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SUPREME COURT OF THE STATE OF NEW YORK

COUNTY OF NEW YORK


FEDERAL HOUSING FINANCE AGENCY,
AS CONSERVATOR FOR THE FEDERAL
NATIONAL MORTGAGE ASSOCIATION
AND THE FEDERAL HOME LOAN
MORTGAGE CORPORATION,
Plaintiff,
-against-
MORGAN STANLEY, MORGAN STANLEY
& CO., INC., MORGAN STANLEY
MORTGAGE CAPITAL HOLDINGS LLC
d/b/a MORGAN STANLEY MORTGAGE
CAPITAL, INC., MORGAN STANLEY ABS
CAPITAL I, INC., MORGAN STANLEY
CAPITAL I, INC., SAXON CAPITAL, INC.,
SAXON FUNDING MANAGEMENT LLC
f/k/a SAXON FUNDING MANAGEMENT,
INC., SAXON ASSET SECURITIES
COMPANY, CREDIT SUISSE SECURITIES
(USA) LLC f/k/a CREDIT SUISSE FIRST
BOSTON LLC, RBS SECURITIES, INC. d/b/a
RBS GREENWICH CAPITAL and f/k/a
GREENWICH CAPITAL MARKETS, INC.,
GAIL P. MCDONNELL, HOWARD
HUBLER, CRAIG S. PHILLIPS,
ALEXANDER C. FRANK, DAVID R.
WARREN, JOHN E. WESTERFIELD, and
STEVEN S. STERN,
Defendants.
Index No. ____
COMPLAINT
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TABLE OF CONTENTS
Page
NATURE OF ACTION...................................................................................................................1
PARTIES .........................................................................................................................................5
Plaintiff and the GSEs..........................................................................................................5
Defendants ...........................................................................................................................5
Morgan Stanley Defendants.................................................................................................5
Non-MS Defendants ............................................................................................................8
Individual Defendants..........................................................................................................8
Non-Party Originators........................................................................................................10
JURISDICTION AND VENUE....................................................................................................10
FACTUAL ALLEGATIONS ........................................................................................................11
I. FACTUAL ALLEGATIONS APPLICABLE TO ALL CLAIMS....................................11
A. The Securitizations.................................................................................................11
1. Residential Mortgage-Backed Securitizations Generally..........................11
2. Securitizations At Issue In This Case ........................................................13
3. Securitization Process ................................................................................17
a. The Sponsors Grouped Mortgage Loans in Special Purpose
Trusts..............................................................................................17
b. The Trusts Issued Securities Backed by the Loans........................18
B. DEFENDANTS PARTICIPATION IN THE SECURITIZATION
PROCESS..............................................................................................................22
1. Defendant MS............................................................................................23
2. Defendant SCI............................................................................................24
3. Defendants MSMC and SFM.....................................................................24
4. Defendants MSAC, MSC, and SASC........................................................26
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5. Defendant MS&Co. ...................................................................................26
6. Non-MS Defendants ..................................................................................27
7. Individual Defendants................................................................................27
C. STATEMENTS IN THE PROSPECTUS SUPPLEMENTS.................................28
1. Compliance With Underwriting Guidelines ..............................................28
2. Occupancy Status of Borrower ..................................................................31
3. Loan-to-Value Ratios.................................................................................33
4. Credit Ratings ............................................................................................36
D. FALSITY OF STATEMENTS IN THE REGISTRATION
STATEMENTS AND PROSPECTUS SUPPLEMENTS.....................................38
1. The Statistical Data Provided in the Prospectus Supplements
Concerning Owner-Occupancy and Loan-To-Value Ratios Was
Materially False .........................................................................................38
a. Owner-Occupancy Data was Materially False ..............................39
b. Loan-to-Value Data was Materially False .....................................41
2. The Originators of the Underlying Mortgage Loans Systematically
Disregarded Their Underwriting Guidelines .............................................44
a. Government and Private Investigations Confirm That the
Originators of the Loans in the Securitizations
Systematically Failed to Adhere to Their Underwriting
Guidelines ......................................................................................45
i. New Century Violated Its Underwriting Guidelines .........46
ii. WMC Violated Its Underwriting Guidelines.....................49
iii. IndyMac Violated Its Underwriting Guidelines ................50
iv. Wilmington Violated Its Underwriting Guidelines............51
b. The Collapse of the Certificates Credit Ratings Further
Shows that the Mortgage Loans were not Originated in
Adherence to the Stated Underwriting Guidelines ........................52
c. The Surge in Mortgage Delinquency and Default Further
Demonstrates that the Mortgage Loans Were Not
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Originated in Adherence to the Stated Underwriting
Guidelines ......................................................................................54
E. FANNIE MAES AND FREDDIE MACS PURCHASES OF THE
CERTIFICATES....................................................................................................56
F. FANNIE MAE AND FREDDIE MAC WERE DAMAGED BY
DEFENDANTS VIOLATIONS OF SECTIONS 11, 12, AND 15 OF
THE SECURITIES ACT.......................................................................................57
II. ADDITIONAL FACTUAL ALLEGATIONS ..................................................................58
A. Defendants Were Incentivized to Fund Risky Residential Mortgage Loans
and To Securitize and Sell Them to Investors ......................................................59
B. Defendants Material Misrepresentations and Omissions in the Offering
Materials ................................................................................................................63
C. The Fraud Defendants Knew or Were Reckless in Not Knowing That
Their Representations Were False and Misleading ..............................................68
D. Fannie Mae and Freddie Mac Justifiably Relied on the Misrepresentations
and Omissions in the Offering Materials and Were Damaged by
Defendants Fraudulent Conduct ...........................................................................77
FIRST CAUSE OF ACTION........................................................................................................79
SECOND CAUSE OF ACTION...................................................................................................82
THIRD CAUSE OF ACTION.......................................................................................................85
FOURTH CAUSE OF ACTION...................................................................................................88
FIFTH CAUSE OF ACTION........................................................................................................91
SIXTH CAUSE OF ACTION .......................................................................................................94
SEVENTH CAUSE OF ACTION.................................................................................................97
EIGHTH CAUSE OF ACTION..................................................................................................100
NINTH CAUSE OF ACTION.....................................................................................................101
TENTH CAUSE OF ACTION....................................................................................................103
PRAYER FOR RELIEF ..............................................................................................................105
Plaintiff Federal Housing Finance Agency (Plaintiff or FHFA), as Conservator of the
Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage
Corporation (Freddie Mac), by its attorneys Kasowitz, Benson, Torres & Friedman LLP, for its
Complaint against the defendants named herein (Defendants), alleges as follows:
NATURE OF ACTION
1. This action arises from false and misleading statements and omissions in
registration statements, prospectuses, and other offering materials pursuant to which certain
residential mortgage-backed securities (RMBS) were purchased by Fannie Mae and Freddie
Mac (together, the Government-Sponsored Enterprises or GSEs). Among other things, these
documents falsely represented that the mortgage loans underlying the RMBS complied with
certain underwriting guidelines and standards, and presented a false picture of the characteristics
and riskiness of those loans. These representations were material to the GSEs, as they would
have been to any reasonable investor, and their falsity violates Sections 11, 12(a)(2), and 15 of
the Securities Act of 1933, 15 U.S.C. 77a et seq., as well as Sections 13.1-522(A)(ii) and 13.1-
522(C) of the Virginia Code and Sections 31-5606.05(a)(1)(B) and 31-5606.05(c) of the District
of Columbia Code. The GSEs justifiably relied on Defendants misrepresentations and
omissions of material fact to their detriment. In addition to their strict statutory liability under
federal securities law and liability under state law, Defendants statements and omissions give
rise to liability under state common law.
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2. Between September 12, 2005 and September 27, 2007, Fannie Mae and Freddie
Mac purchased over $10.58 billion in Certificates issued in connection with 33 securitizations
that were virtually all sponsored and underwritten by Morgan Stanley entities.
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3. The Certificates were offered for sale pursuant to one of seven shelf registration
statements (the Shelf Registration Statements) filed with the Securities and Exchange
Commission (the SEC). For each of the 33 securitizations sold to Fannie Mae and Freddie
Mac (the Securitizations), a prospectus (Prospectus) and prospectus supplement
(Prospectus Supplement) were filed with the SEC as part of the Registration Statement for that
Securitization.
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The Certificates were marketed and sold to Fannie Mae and Freddie Mac
pursuant to the Registration Statements.
4. The Registration Statements contained representations concerning, among other
things, the characteristics and credit quality of the mortgage loans underlying the Securitizations,
the creditworthiness of the borrowers on those underlying mortgage loans, and the origination
and underwriting practices used to make and approve the loans. Such representations were
material to a reasonable investors decision to invest in the Certificates, and they were material to
the GSEs. Unbeknownst to Fannie Mae and Freddie Mac, those representations were false
because, among other reasons, material percentages of the underlying mortgage loans were not
originated in accordance with the represented underwriting standards and origination practices,
and did not have the credit and other characteristics set forth in the Registration Statements.
1
For purposes of this Complaint, the securities issued under the Registration Statements
(defined in note 2, infra) are generally referred to as Certificates. Holders of Certificates are
referred to as Certificateholders.
2
The term Registration Statement as used herein and in Appendix A incorporates the
Shelf Registration Statement, the Prospectus and the Prospectus Supplement for each referenced
Securitization, except where otherwise indicated.
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5. Among other things, the Registration Statements presented the loan origination
guidelines of the mortgage loan originators who originated the loans that underlay the
Certificates. The Registration Statements falsely represented that those guidelines were adhered
to except in specified circumstances, when in fact the guidelines systematically were disregarded
in that the loans were not originated in accordance with those guidelines.
6. The Registration Statements also set forth for each Securitization statistical
summaries of the characteristics of the underlying mortgage loans, such as the percentage of
loans secured by owner-occupied properties and the percentage of the loan groups aggregate
principal balance with loan-to-value ratios within specified ranges. This information was
material to reasonable investors, and it was material to the GSEs. However, a loan-level analysis
of a sample of loans for each Securitization -- a review that encompassed in the aggregate
thousands of mortgages across all of the Securitizations -- has revealed that for each
Securitization the statistical summaries were false and misleading. The statistics reflected or
were based upon misrepresentations of other key characteristics of the mortgage loans and
inflated property values.
7. For example, the percentage of owner-occupied properties in the loan pool
underlying a RMBS is a material risk factor to the purchasers of certificates, such as Fannie Mae
and Freddie Mac, because a borrower who actually lives in a mortgaged property is generally
less likely to stop paying the mortgage and more likely to take care of the property. The loan-
level review revealed that the true percentage of owner-occupied properties for the loans
supporting the Certificates was materially lower than that represented in the Prospectus
Supplements. Likewise, the Prospectus Supplements misrepresented such material information
as loan-to-value ratios -- that is, the relationship between the principal amount of the loans and
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the true value of the mortgaged properties securing those loans -- and the ability of the individual
mortgage holders to satisfy their debts.
8. The Registration Statements also set forth ratings for each of the Securitizations.
Those AAA ratings were material to a reasonable investors decision to purchase the Certificates,
and they were material to the GSEs. The ratings for the Securitizations were materially
inaccurate and were based upon false information supplied by Defendants. Upon information
and belief, neither the Defendants nor the rating agencies who issued the ratings believed or had
any sound basis to believe in their truthfulness.
9. Defendants, who are issuers, sponsors, and/or underwriters of the Certificates
purchased by the GSEs, or signatories of the Registration Statements pursuant to which the
Certificates purchased by the GSEs were offered, are liable for the misstatements and omissions
of material fact contained in the Registration Statements and other offering materials because
they prepared, signed, filed and/or used these documents to market and sell the Certificates to
Fannie Mae and Freddie Mac, or because they directed and controlled the entities that did so.
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10. Defendants misstatements and omissions of material facts have caused loss and
injury to the GSEs. The GSEs purchased the highest tranches of Certificates offered for sale by
Defendants. Fannie Mae and Freddie Mac would not have purchased these Certificates but for
Defendants material misrepresentations and omissions concerning the mortgage loans
underlying the RMBS. As the truth concerning the misrepresented and omitted facts has come to
light, and as the hidden risks have materialized, the market value of Certificates purchased by
Fannie Mae and Freddie Mac has declined. Fannie Mae and Freddie Mac have suffered
3
The Certificates purchased by Fannie Mae and Freddie Mac are identified infra in Tables
10 and 11.
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enormous financial losses as a result of the Defendants misrepresentations and omissions.
FHFA, as Conservator for the GSEs, now seeks rescission and damages for those losses.
PARTIES
Plaintiff and the GSEs
11. Plaintiff Federal Housing Finance Agency is a federal agency located at 1700 G
Street, NW in Washington, D.C. FHFA was created on July 30, 2008, pursuant to the Housing
and Economic Recovery Act of 2008 (HERA), Pub L. No. 110-289, 122 Stat. 2654, codified at
12 U.S.C. 4617 et seq. (HERA), to oversee Fannie Mae, Freddie Mac and the Federal Home
Loan Banks. On September 6, 2008, the Director of FHFA, also pursuant to HERA, placed
Fannie Mae and Freddie Mac into conservatorship and appointed FHFA as Conservator. In that
capacity, FHFA has the authority to exercise all rights and remedies of Fannie Mae and Freddie
Mac, including but not limited to, the authority to bring suits on behalf of and/or for the benefit
of the GSEs. 12 U.S.C. 4617(b)(2).
12. Fannie Mae and Freddie Mac are government-sponsored enterprises chartered by
Congress with a mission to provide liquidity, stability and affordability to the United States
housing and mortgage markets. As part of this mission, Fannie Mae and Freddie Mac invested in
RMBS. Fannie Mae is located at 3900 Wisconsin Avenue, NW in Washington, D.C. Freddie
Mac is located at 8200 Jones Branch Drive in McLean, Virginia.
Defendants
Morgan Stanley Defendants
13. Defendant Morgan Stanley (MS) is a financial holding company regulated by
the Board of Governors of the Federal Reserve System, and an SEC-registered broker-dealer.
Morgan Stanley is a Delaware corporation with its principal place of business at 1585 Broadway,
New York, New York 10036. MS is a global financial services firm that trades on the New York
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Stock Exchange under the ticker MS. MSs business units include its Institutional Securities
division which, among other things, acts as an underwriter of RMBS, provides warehouse
lending to subprime and other mortgage originators, trades, makes markets and takes proprietary
positions in RMBS, and structures debt securities and derivatives involving mortgage-related
securities.
14. Defendant Morgan Stanley & Co., Inc. (MS&Co.) is a wholly-owned subsidiary
of MS, incorporated in the State of Delaware, with its principal offices at 1585 Broadway, New
York, New York 10036. Defendant MS&Co. was the lead or co-lead underwriter for 30 of the
33 Securitizations. Fannie Mae and Freddie Mac purchased the Certificates for 30 of the 33
Securitizations from MS&Co. in its capacity as lead or co-lead underwriter for the
Securitizations.
15. Defendant Morgan Stanley ABS Capital I, Inc. (MSAC) is a wholly-owned
subsidiary of MS, incorporated in the State of Delaware, with its principal offices at 1585
Broadway, New York, New York 10036. Defendant MSAC was the depositor for 16 of the 33
Securitizations. As depositor, MSAC was responsible for preparing and filing reports required
under the Securities Exchange Act of 1934.
16. Defendant Morgan Stanley Capital I, Inc. (MSC) is a wholly-owned subsidiary
of MS incorporated in the State of Delaware with its principal offices located at 1585 Broadway,
New York, New York 10036. Defendant MSC was the depositor for 10 Securitizations. As
depositor, MSC was responsible for preparing and filing reports required under the Securities
Exchange Act of 1934 with respect to the Securitizations.
17. Defendant Morgan Stanley Mortgage Capital Holdings LLC d/b/a Morgan
Stanley Mortgage Capital, Inc. (MSMC) is a New York limited liability company, and a
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wholly-owned subsidiary of MS with its principal offices at 1221 Avenue of the Americas, New
York, New York 10020. Defendant MSMC was the sponsor of one of the Securitizations. By
virtue of a June 17, 2007 merger, Defendant MSMC became the successor-in-interest to Morgan
Stanley Mortgage Capital, Inc. (MCI) (the term MSMC/MCI is used herein to refer to
MSMC on its own behalf and as successor-in-interest to MCI), which was the sponsor of 20 of
the Securitizations. Defendant MSMC is liable as a matter of law as successor to MCI as the
surviving entity in its direct merger with MCI. Defendant MSMC is also the direct parent and
sole owner of Defendant Saxon Capital, Inc. (SCI). Defendant MS is the direct parent and sole
owner of Defendants MS&Co., MSAC, MSC, and MSMC.
18. SCI is a Maryland corporation with an office located at 300 International Drive,
100, Williamsville, New York 14421. On December 4, 2006, SCI merged with Angle Merger
Subsidiary Corporation, which was a wholly-owned subsidiary of MCI. As Defendant MSMC is
the successor-in-interest to MCI, Defendant SCI is now a wholly-owned subsidiary of MSMC.
Defendant SCI is the sole owner and direct parent of Defendant Saxon Funding Management
LLC (SFM).
19. SFM, a wholly-owned subsidiary of Defendant SCI, is a Delaware limited
liability company registered to do business in New York. Prior to December 4, 2006 when
Defendant SCI merged with a MS subsidiary, SFM was known as Saxon Funding Management,
Inc. Defendant SFM was the sponsor of two Securitizations.
20. Defendant Saxon Asset Securities Company (SASC) is a wholly-owned
subsidiary of Defendant SFM incorporated in the State of Virginia. Defendant SASC was the
depositor for four Securitizations and transacted business in New York. SASC, as depositor, was
also responsible for preparing and filing reports required under the Securities Exchange Act of
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1934. Defendants MS, MS&Co., MSAC, MSC, MSMC, SCI, SFM and SASC are referred to
together herein as Morgan Stanley.
Non-MS Defendants
21. Defendant Credit Suisse Securities (USA) LLC (Credit Suisse) is a corporation
organized and existing under the laws of the State of Delaware with its principal place of
business at 11 Madison Ave., New York, New York 10010. Prior to January 16, 2006, Credit
Suisse was known as Credit Suisse First Boston LLC. Credit Suisse is an SEC-registered broker-
dealer, and was the co-lead underwriter for four of the Securitizations. The GSEs purchased the
Certificates for two Securitizations from Credit Suisse.
22. Defendant RBS Securities, Inc., doing business as RBS Greenwich Capital
(RBS), is an SEC-registered broker-dealer incorporated in the State of Delaware with offices
located at 101 Park Avenue, New York, New York 10178. Prior to April 2009, RBS was known
as Greenwich Capital Markets, Inc. RBS was co-lead underwriter for three Securitizations and
sold the Certificates for one Securitization to Freddie Mac.
Individual Defendants
23. Defendant Gail P. McDonnell (Ms. McDonnell) is an individual residing in
New York, New York. Ms. McDonnell was a Managing Director and Head of the Securitized
Products group at Defendant MS. She also served as a Director at Defendant MSAC. Ms.
McDonnell signed two of the Shelf Registration Statements and the amendments thereto.
24. Defendant Howard Hubler (Mr. Hubler) is an individual residing in Rumson,
New Jersey. Mr. Hubler was a Managing Director at the Proprietary Trading group at Defendant
MS and transacted business in New York. He also served as a Director at Defendant MSAC.
Mr. Hubler signed one Shelf Registration Statement and the amendments thereto.
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25. Defendant Craig S. Phillips (Mr. Phillips) is an individual residing in New
Canaan, Connecticut. Mr. Phillips was a Managing Director and Global Head of the Securitized
Products group at Defendant MS and transacted business in New York. He also served as
President and Director at Defendant MSAC. Mr. Phillips signed two of the Shelf Registration
Statements and the amendments thereto.
26. Defendant Alexander C. Frank (Mr. Frank) is an individual residing in New
York, New York. Mr. Frank was a Treasurer, a Managing Director and the Head of Operational
Risk Management at Defendant MS from 1985 through 2008. He also served as Treasurer at
Defendant MSAC. Mr. Frank signed one Shelf Registration Statement and the amendment
thereto.
27. Defendant David R. Warren (Mr. Warren) is an individual residing in New
York, New York. Mr. Warren was a Managing Director in the Mortgage Capital Markets group
and the Global Head of the Structured Credit Trading group at Defendant MS. He also served as
President and Director at Defendant MSC. Mr. Warren signed three of the Shelf Registration
Statements and the amendments thereto.
28. Defendant John E. Westerfield (Mr. Westerfield) is an individual residing in
Bronxville, New York. Mr. Westerfield was Global Head of Real Estate Lending and Global
Head of Commercial Mortgage Backed Securities at Defendant MS from 1985 through 2008.
He also served as a Director at Defendant MSC. Mr. Westerfield signed one Shelf Registration
Statement and the amendments thereto.
29. Defendant Steven S. Stern (Mr. Stern) is an individual residing in Connecticut.
Mr. Stern was Global Head of Real Estate Lending at Defendant MS, is currently employed in
the Global Commercial Mortgage-Backed Securities group at Defendant MS, and transacted
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business in New York. He also served as a Director at Defendant MSC. Mr. Stern signed one
Shelf Registration Statement and the amendments thereto. Messrs. Hubler, Phillips, Frank,
Warren, Westerfield, and Stern, and Ms. McDonnell are together referred to herein as the
Individual Defendants.
Non-Party Originators
30. The loans underlying the Certificates were acquired by the sponsor for each
Securitization from third-party mortgage originators, including Aames Capital Corporation
(Aames Capital); Accredited Home Lenders, Inc. (Accredited Home); Wilmington Finance
Inc. (Wilmington); American Home Mortgage Corporation (American Home); Decision One
Mortgage Company, LLC (Decision One); First National Bank of Nevada (First National);
First NLC Financial Services LLC (First NLC); GreenPoint Mortgage Funding Inc.
(GreenPoint); Hemisphere National Bank (Hemisphere); New Century Mortgage
Corporation (New Century) and its subsidiary Home 123 Corporation (Home123); IndyMac
Federal Savings Bank (IndyMac); Meritage Mortgage Corporation (Meritage); MortgageIT,
Inc. (MortgageIT); Wachovia Mortgage Corporation (Wachovia); and WMC Mortgage
Corp. (WMC). Morgan Stanley Credit Corporation (MSCC) and SMI, both subsidiaries of
MS, also originated some of the loans underlying the Certificates for the Securitizations.
Together, the entities identified in this paragraph are referred to as the Non-Party Originators.
JURISDICTION AND VENUE
31. This Court has jurisdiction over this action pursuant to Section 22 of the
Securities Act of 1933, 15 U.S.C. 77v, and Section 7 of Article VI of the New York State
Constitution.
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32. This Court has personal jurisdiction over the Defendants pursuant to C.P.L.R.
301 and 302.
33. Venue is proper in this district pursuant to C.P.L.R. 503 because one or more of
the parties resides in New York County, New York. The underwriters reside or have their
principal place of business in this district and many of the alleged acts and transactions,
including the preparation and dissemination of the Registration Statements, occurred in
substantial part within New York County, New York.
FACTUAL ALLEGATIONS
I. FACTUAL ALLEGATIONS APPLICABLE TO ALL CLAIMS
34. The factual allegations set forth in paragraphs 35 through 133 below are made
with respect to all causes of action against Defendants and are sufficient to establish Defendants
strict statutory liability under the federal Securities Act, and the Securities Acts of the District of
Columbia and Virginia. With respect to such liability, no allegations are made or intended, and
none are necessary, concerning Defendants state of mind. Defendants are strictly liable, without
regard to intent on their part or reliance on Freddie Macs part, for the misstatements in, and
material omissions from, the Registration Statements under Sections 11 and 12 and, for control
person defendants, under Section 15, of the Securities Act, as well as Sections 13.1-522(A)(ii)
and 13.1-522(C) of the Virginia Code and Sections 31-5606.05(a)(1)(B) and 31-5606.05(c) of
the District of Columbia Code.
A. The Securitizations
1. Residential Mortgage-Backed Securitizations Generally
35. Asset-backed securitization involves pooling cash-producing financial assets and
issuing securities backed by those pools of assets. In residential mortgage-backed
securitizations, the cash-producing financial assets are residential mortgage loans.
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36. In the most common form of securitization of mortgage loans, a sponsor -- the
entity that acquires or originates the mortgage loans and initiates the securitization -- directly or
indirectly transfers a portfolio of mortgage loans to a trust. In many instances, the transfer of
assets to the trust is a two-step process in which the sponsor first transfers the financial assets to
an intermediate entity, typically referred to as a depositor, and then the depositor transfers the
assets to a trust. The trust is established pursuant to a pooling and servicing agreement or trust
indenture entered into by, among others, the depositor for that securitization.
37. RMBS are the securities backed by the underlying mortgage loans in the trust.
Some residential mortgage-backed securitizations are created from more than one cohort of
loans, called collateral groups, in which case the trust issues different tranches of securities
backed by different groups of loans. For example, a securitization may involve two groups of
mortgages, with some securities backed primarily by the first group, and others primarily by the
second group. Purchasers of the securities (in the form of certificates) acquire an ownership
interest in the assets of the trust, which in turn owns the loans. These purchasers are thus
dependent for repayment of principal and payment of interest upon the cash-flows from the
designated group of mortgage loans -- primarily mortgagors payments of principal and interest
on the mortgage loans held by the related trust.
38. RMBS are generally issued and sold pursuant to registration statements filed with
the SEC. These registration statements include prospectuses, which describe the general
structure of the investment, and prospectus supplements, which set forth detailed descriptions of,
among other things, the mortgage groups underlying the certificates. Certificates are issued by
the trust and sold pursuant to the registration statement, the prospectus and prospectus
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supplement. Underwriters purchase the certificates from the trust and then offer, sell or
distribute the certificates to investors.
39. A mortgage servicer manages the collection of proceeds from the mortgage loans.
The servicer is responsible for collecting homeowners mortgage loan payments, which the
servicer remits to the trustee after deducting a monthly servicing fee. The servicers duties
include making collection efforts on delinquent loans, initiating foreclosure proceedings, and
determining when to charge off a loan by writing down its balance. The servicer is required to
report key information about the loans to the trustee. The trustee (or trust administrator)
administers the trust funds and delivers payments due each month on the certificates to the
investors.
2. Securitizations At Issue In This Case
40. This case involves the following 33 Securitizations:
i. Aames Mortgage Investment Trust 2005-4, Mortgage Backed Notes
(AMIT 2005-4);
ii. Morgan Stanley ABS Capital I Inc. Trust, Mortgage Pass-Through
Certificates, Series 2005-HE5 (MSAC 2005-HE5);
iii. Morgan Stanley ABS Capital I Inc. Trust, Mortgage Pass-Through
Certificates, Series 2005-HE6 (MSAC 2005-HE6);
iv. Morgan Stanley ABS Capital I Inc. Trust, Mortgage Pass-Through
Certificates, Series 2006-HE6 (MSAC 2006-HE3);
v. Morgan Stanley ABS Capital I Inc. Trust, Mortgage Pass-Through
Certificates, Series 2006-HE5 (MSAC 2006-HE5)
vi. Morgan Stanley ABS Capital I Inc. Trust, Mortgage Pass-Through
Certificates, Series 2006-HE6 (MSAC 2006-HE6);
vii. Morgan Stanley ABS Capital I Inc. Trust, Mortgage Pass-Through
Certificates, Series 2006-HE8 (MSAC 2006-HE8);
viii. Morgan Stanley Capital I Inc. Trust, Mortgage Pass-Through Certificates,
Series 2006-NC2 (MSC 2006-NC2);
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ix. Morgan Stanley ABS Capital I Inc. Trust, Mortgage Pass-Through
Certificates, Series 2006-NC3 (MSAC 2006-NC3);
x. Morgan Stanley ABS Capital I Inc. Trust, Mortgage Pass-Through
Certificates, Series 2006-NC4 (MSAC 2006-NC4);
xi. Morgan Stanley ABS Capital I Inc. Trust, Mortgage Pass-Through
Certificates, Series 2006-WMC2 (MSAC 2006-WMC2);
xii. Morgan Stanley ABS Capital I Inc. Trust, Mortgage Pass-Through
Certificates, Series 2007-HE1 (MSAC 2007-HE1);
xiii. Morgan Stanley ABS Capital I Inc. Trust, Mortgage Pass-Through
Certificates, Series 2007-HE5 (MSAC 2007-HE5);
xiv. Morgan Stanley ABS Capital I Inc. Trust, Mortgage Pass-Through
Certificates, Series 2007-HE7 (MSAC 2007-HE7);
xv. Morgan Stanley ABS Capital I Inc. Trust, Mortgage Pass-Through
Certificates, Series 2007-NC1 (MSAC 2007-NC1);
xvi. Morgan Stanley Capital I Inc. Trust, Mortgage Pass-Through Certificates,
Series 2006-HE2 (MSC 2006-HE2);
xvii. Morgan Stanley Mortgage Loan Trust, Mortgage Pass-Through
Certificates, Series 2005-10 (MSM 2005-10);
xviii. Morgan Stanley Mortgage Loan Trust, Mortgage Pass-Through
Certificates, Series 2005-7 (MSM 2005-7);
xix. Morgan Stanley Mortgage Loan Trust, Mortgage Pass-Through
Certificates, Series 2006-2 (MSM 2006-2);
xx. Morgan Stanley Mortgage Loan Trust, Mortgage Pass-Through
Certificates, Series 2006-16AX (MSM 2006-16AX);
xxi. Morgan Stanley Mortgage Loan Trust, Mortgage Pass-Through
Certificates, Series 2007-2AX (MSM 2007-2AX);
xxii. Morgan Stanley Mortgage Loan Trust, Mortgage Pass-Through
Certificates, Series 2007-7AX (MSM 2007-7AX);
xxiii. Morgan Stanley Mortgage Loan Trust, Mortgage Pass-Through
Certificates, Series 2007-5AX (MSM 2007-5AX);
xxiv. Morgan Stanley Home Equity Loan Trust, Mortgage Pass-Through
Certificates, Series 2005-4 (MSHEL 2005-4);
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xxv. New Century Home Equity Loan Trust, Asset Backed Pass-Through
Certificates, Series 2005-B (NCHET 2005-B);
xxvi. New Century Home Equity Loan Trust, Asset Backed Pass-Through
Certificates, Series 2005-C (NCHET 2005-C);
xxvii. New Century Home Equity Loan Trust, Asset Backed Pass-Through
Certificates, Series 2005-D (NCHET 2005-D);
xxviii. Saxon Asset Securities Trust, Mortgage Loan Asset Backed Notes, Series
2005-3 (SAST 2005-3);
xxix. Saxon Asset Securities Trust, Mortgage Loan Asset Backed Notes, Series
2006-1 (SAST 2006-1);
xxx. Saxon Asset Securities Trust, Mortgage Loan Asset Backed Notes, Series
2006-2 (SAST 2006-2);
xxxi. Saxon Asset Securities Trust, Mortgage Loan Asset Backed Notes, Series
2007-1 (SAST 2007-1);
xxxii. Saxon Asset Securities Trust, Mortgage Loan Asset Backed Notes, Series
2007-2 (SAST 2007-2); and
xxxiii. Saxon Asset Securities Trust, Mortgage Loan Asset Backed Notes, Series
2007-3 (SAST 2007-3).
41. For each of the 33 Securitizations, Table 1 identifies the: (1) sponsor;
(2) depositor; (3) underwriter; (4) principal amount issued for the tranches
4
purchased by the
GSEs; (5) date of issuance; and (6) the loan group or groups backing the Certificate for that
Securitization (referred to as the Supporting Loan Groups).
4
A tranche is one of the classes of debt securities issued as part of a single bond or
instrument. Securities are often issued in tranches to meet different investor objectives for
portfolio diversification.
16
Table 1
Transaction Tranche Sponsor Depositor Underwriters
Principal
Amount Issued
($)
Date of
Issuance
Supporting
Loan
Group(s)
AMIT 2005-4 1A1 Aames
Investment
MSAC MS&Co.
Bear
RBS
Citi
446,899,000.00 09/12/05 Group 1
MSAC 2005-HE5 A1 MSMC MSAC MS&Co. 441,470,000.00 10/28/05 Group I
MSAC 2005-HE6 A1 MSMC MSAC MS&Co. 337,122,000.00 11/29/05 Group I
MSAC 2006-HE3 A1 MSMC MSAC MS&Co. 381,635,000.00 05/25/06 Group I
MSAC 2006-HE5 A1 MSMC MSAC MS&Co. 319,485,000.00 06/30/06 Group I
MSAC 2006-HE6 A1 MSMC MSAC MS&Co. 324,649,000.00 09/27/06 Group I
MSAC 2006-HE8 A1 MSMC MSAC MS&Co. 226,710,000.00 11/29/06 Group I
MSC 2006-NC2 A1 MSMC MSC MS&Co. 430,640,000.00 03/30/06 Group I
MSAC 2006-NC3 A1 MSMC MSAC MS&Co. 426,670,000.00 04/28/06 Group I
MSAC 2006-NC4 A1 MSMC MSAC MS&Co. 536,150,000.00 06/23/06 Group I
MSAC 2006-WMC2 A1 MSMC MSAC MS&Co. 581,960,000.00 06/28/06 Group I
MSAC 2007-HE1 A1 MSMC MSAC MS&Co. 309,100,000.00 01/26/07 Group I
MSAC 2007-HE5 A1 MSMC MSAC MS&Co. 119,919,000.00 04/26/07 Group I
MSAC 2007-HE7 A1 MSMC MSAC MS&Co. 670,205,000.00 09/28/07 Group I
MSAC 2007-NC1 A1 MSMC MSAC MS&Co. 320,559,000.00 01/26/07 Group I
MSC 2006-HE2 A1 MSMC MSC MS&Co. 435,720,000.00 04/28/06 Group I
MSHEL 2005-4 A1 MSMC MSAC MS&Co. 335,337,000.00 11/29/05 Group I
MSM 2005-10 3A MSMC MSC MS&Co. 40,296,000.00 11/30/05 Group 3
MSM 2005-7 5A MSMC MSC MS&Co. 26,951,000.00 10/31/05 Group 5
MSM 2006-16AX 1A MSMC MSC MS&Co. 182,501,000.00 10/31/06 Group 1
MSM 2006-2 7A1 MSMC MSC MS&Co. 31,903,000.00 01/31/06 Group 7
7A2 MSMC MSC MS&Co. 3,545,000.00 01/31/06 Group 7
MSM 2007-2AX 1A MSMC MSC MS&Co. 157,974,000.00 01/31/07 Group 1
MSM 2007-5AX 1A MSMC MSC MS&Co. 127,608,000.00 02/28/07 Group 1
MSM 2007-7AX 1A MSMC MSC MS&Co. 177,425,000.00 04/30/07 Group 1
NCHET 2005-B A1 NC Capital
Corporation
New Century
Mortgage
Securities, Inc.
MS&Co.
Bear
590,249,000.00 09/29/05 Group I
NCHET 2005-C A1 NC Capital
Corporation
New Century
Mortgage
Securities, Inc.
MS&Co. 549,534,000.00 12/06/05 Group I
NCHET 2005-D A1 NC Capital
Corporation
New Century
Mortgage
Securities, Inc.
MS&Co.
Credit Suisse
Deutsche Bank
411,566,000.00 12/28/05 Group I
SAST 2005-3 A1A SFM SASC RBS
BOA
Credit Suisse
Merrill
360,900,000.00 09/29/05 Group 1
SAST 2006-1 A1 SFM SASC Credit Suisse
BOA
RBS
JPM
Merrill
199,612,000.00 05/02/06 Group 1
17
Transaction Tranche Sponsor Depositor Underwriters
Principal
Amount Issued
($)
Date of
Issuance
Supporting
Loan
Group(s)
SAST 2006-2 A2 SFM SASC Credit Suisse
BOA
RBS
JPM
Merrill
197,374,000.00 06/07/06 Group 2
A1 SFM SASC Credit Suisse
BOA
RBS
JPM
Merrill
197,376,000.00 06/07/06 Group 1
SAST 2007-1 A1 SFM SASC MS&Co. 209,071,000.00 03/07/07 Group 1
SAST 2007-2 A1 SFM SASC MS&Co. 192,705,000.00 04/30/07 Group 1
SAST 2007-3 1A SFM SASC MS&Co. 569,917,000.00 08/03/07 Group 1
1M1 SFM SASC MS&Co. 36,690,000.00 08/03/07 Group 1
1M2 SFM SASC MS&Co. 33,021,000.00 08/03/07 Group 1
1M3 SFM SASC MS&Co. 21,198,000.00 08/03/07 Group 1
1M4 SFM SASC MS&Co. 17,937,000.00 08/03/07 Group 1
1M5 SFM SASC MS&Co. 17,937,000.00 08/03/07 Group 1
1M6 SFM SASC MS&Co. 16,307,000.00 08/03/07 Group 1
3. Securitization Process
a. The Sponsors Grouped Mortgage Loans in Special Purpose
Trusts
42. In each case the sponsor purchased the mortgage loans underlying the Certificates
purchased by the GSEs for its Securitizations either directly from the originators or through
affiliates of the originators. Defendant MSMC/MCI sponsored 23 Securitizations; Defendant
SFM sponsored six Securitizations; and the remaining four Securitizations were sponsored by
non-parties.
43. For the 20 Securitizations that they sponsored, MSMC and SFM sold the
mortgage loans to Defendants MSAC, MSC and SASC, the depositors. MSAC also acted as the
depositor for one additional Securitization sponsored by non-party Aames Investment
Corporation.
44. As depositors for 30 of the 33 Securitizations, Defendants MSC, MSAC and
SASC transferred the relevant mortgage loans to the respective trusts for each of those
18
Securitizations, in each case pursuant to Assignment and Recognition Agreements or Mortgage
Loan Purchase Agreements that contained various representations and warranties regarding the
mortgage loans for the Securitizations.
45. As part of each Securitization, the trustee for that Securitization, on behalf of the
Certificateholders, executed a Pooling and Servicing Agreement (PSA) with the relevant
depositor and the relevant servicer. In each case, the trust, administered by the trustee, was
required to hold the mortgage loans, pursuant to the related PSA and issued Certificates backed
by such loans.
b. The Trusts Issued Securities Backed by the Loans
46. Once the mortgage loans were transferred to the trusts in accordance with the
PSAs, each trust issued Certificates backed by the underlying mortgage loans. The Certificates
were then sold to investors, including Fannie Mae and Freddie Mac, who purchased the highest
tranches of the Certificates. Each Certificate entitles its holder to a specified portion of the cash
flows from the underlying mortgages in the supporting loan group for that Certificate.
Therefore, the value of the Certificates, derived in part from the likelihood of payment of
principal and interest on the Securitizations, depends upon the credit quality of the underlying
mortgages, i.e., the risk of default by borrowers and the recovery value upon default of
foreclosed-upon properties.
47. The Certificates purchased by the GSEs were issued and sold pursuant to Shelf
Registration Statements filed with the SEC on a Form S-3.
5
The Shelf Registration Statements
5
Defendant MSAC filed two Shelf Registration Statements that were used to market 16 of
the Securitizations; Defendant MSC filed two Shelf Registration Statements that were used to
market eight of the Securitizations; and Defendant SASC filed two Shelf Registration Statements
that were used to market six of the Securitizations. The remaining Registration Statement was
19
(S-3) were amended by one or more Forms S-3/A (the Amendments or S-3/A) filed with
the SEC. The Individual Defendants signed six of the seven total Shelf Registration Statements
(and amendments thereto) that were filed, in each case, by MSAC, MSC or SASC. The SEC
filing number, registrants, signatories, and filing dates for all seven Shelf Registration Statements
with Amendments, as well as the Certificates purchased by the GSEs covered by each Shelf
Registration Statement, are reflected in Table 2 below.
filed by non-party New Century Mortgage Securities, Inc. and was used to market three of the
Securitizations.
20
Table 2
SEC File
No.
Date S-3
Filed
Date(s)
S-3/A(s)
Filed
Registrants Covered Certificates
Signatories of
S-3
Signatories of
S-3/A(s)
6
333-130694 12/23/05 02/21/06
03/10/06
MSAC MSAC 2006-HE3
MSAC 2006-HE5
MSAC 2006-HE6
MSAC 2006-HE8
MSAC 2006-NC3
MSAC 2006-NC4
MSAC 2006-WMC2
MSAC 2007-HE1
MSAC 2007-HE5
MSAC 2007-HE7
MSAC 2007-NC1
Steven Shapiro
Anthony Tufariello
William Forsell
Gail P. McDonnell
Howard Hubler
Steven Shapiro
Anthony Tufariello
William Forsell
Gail P. McDonnell
Howard Hubler
333-121914 01/07/05 05/06/05 MSAC MSAC 2005-HE5
MSAC 2005-HE6
MSHEL 2005-4
AMIT 2005-4
Steven Shapiro
Craig S. Phillips
Alexander C. Frank
Gail P. McDonnell
David R. Warren
Steven Shapiro
Craig S. Phillips
Alexander C. Frank
Gail P. McDonnell
David R. Warren
333-125593 06/07/05 06/28/05
06/30/05
MSC MSC 2006-HE2
MSC 2006-NC2
MSM 2005-10
MSM 2005-7
MSM 2006-2
David R. Warren
Craig S. Phillips
John E. Westerfield
William J. Forsell
David R. Warren
Craig S. Phillips
John E. Westerfield
William J. Forsell
333-130684 12/23/05 02/17/06
03/14/06
MSC MSM 2006-16AX
MSM 2007-2AX
MSM 2007-5AX
MSM 2007-7AX
David R. Warren
William J. Forsell
Anthony B. Tufariello
Steven S. Stern
Anthony B. Tufariello
William J. Forsell
Steven S. Stern
333-123394 03/17/05 New Century NCHET 2005-B
NCHET 2005-C
NCHET 2005-D
Kevin Cloyd
Brad A. Morrice
Patrick J. Flanagan
Edward F. Gotschall
333-111832 01/09/04 01/21/04 SASC SAST 2005-3 Ernest G. Bretana
Michael L. Sawyer
Dean A. Christiansen
Ernest G. Bretana
333-131712 02/09/06 03/17/06
03/30/06
SASC SAST 2006-1
SAST 2006-2
SAST 2007-1
SAST 2007-2
SAST 2007-3
Ernest G. Bretana
Michael L. Sawyer
Orlando Figueroa
Ernest G. Bretana
Michael L. Sawyer
Orlando Figueroa
Robert B. Eastep
Jennifer Sebastian
48. The Prospectus Supplement for each Securitization describes the loan
underwriting guidelines that purportedly were used in connection with the origination of the
underlying mortgage loans. In addition, the Prospectus Supplements purport to provide accurate
6
Some Individual Defendants signed certain S-3/As through a power of attorney.
21
statistics regarding the mortgage loans in each group, including: the ranges of and weighted
average FICO credit scores of the borrowers, the ranges of and weighted average loan-to-value
(LTV) ratios of the loans, the ranges of and weighted average outstanding principal balances
of the loans, the debt-to-income ratios of the borrowers, the geographic distribution of the loans,
the extent to which the loans were for purchase or refinance purposes, information concerning
whether the loans were secured by a property to be used as a primary residence, second home, or
investment property, and information concerning whether the loans were delinquent.
49. The Prospectus Supplement for each Securitization was filed with the SEC as part
of the Registration Statements. The Form 8-Ks attaching the PSAs for each Securitization were
also filed with the SEC. The date on which the Prospectus Supplement and Form 8-K were filed
for each Securitization, as well as the filing number of the Shelf Registration Statement related to
each, are set forth in Table 3 below.
Table 3
Transaction
Date
Prospectus
Supplement
Filed
Date Form 8-K
Attaching PSA
Filing No. of
Related
Registration
Statement
AMIT 2005-4 09/13/05 09/26/05 333-121914
MSAC 2005-HE5 10/31/05 11/15/05 333-121914
MSAC 2005-HE6 11/29/05 12/12/05 333-121914
MSAC 2006-HE3 05/26/06 06/09/06 333-130694
MSAC 2006-HE5 06/30/06 07/17/06 333-130694
MSAC 2006-HE6 09/22/06 10/13/06 333-130694
MSAC 2006-HE8 11/22/06 12/14/06 333-130694
MSC 2006-NC2 03/30/06 04/14/06 333-125593
MSAC 2006-NC3 04/26/06 05/15/06 333-130694
MSAC 2006-NC4 06/20/06 07/11/06 333-130694
MSAC 2006-WMC2 06/23/06 07/20/06 333-130694
MSAC 2007-HE1 01/26/07 02/12/07 333-130694
MSAC 2007-HE5 04/25/07 05/16/07 333-130694
MSAC 2007-HE7 09/28/07 10/16/07 333-130694
MSAC 2007-NC1 01/26/07 02/12/07 333-130694
MSC 2006-HE2 04/26/06 05/15/06 333-125593
MSHEL 2005-4 11/23/05 12/14/05 333-121914
MSM 2005-10 12/01/05 01/13/06 333-125593
MSM 2005-7 10/31/05 01/13/06 333-125593
MSM 2006-16AX 10/30/06 01/25/07 333-130684
22
Transaction
Date
Prospectus
Supplement
Filed
Date Form 8-K
Attaching PSA
Filing No. of
Related
Registration
Statement
MSM 2006-2 (7A1 & 7A2) 02/02/06 01/24/07 333-125593
MSM 2007-2AX 01/29/07 02/16/07 333-130684
MSM 2007-5AX 02/28/07 04/17/07 333-130684
MSM 2007-7AX 04/30/07 09/19/07 333-130684
NCHET 2005-B 09/28/05 10/17/05 333-123394
NCHET 2005-C 12/05/05 12/23/05 333-123394
NCHET 2005-D 12/27/05 01/09/06 333-123394
SAST 2005-3 09/30/05 10/13/05 333-111832
SAST 2006-1 05/01/06 05/08/06 333-131712
SAST 2006-2 (A1 & A2) 06/07/06 06/21/06 333-131712
SAST 2007-1 06/07/06 06/21/06 333-131712
SAST 2007-2 03/07/07 03/22/07 333-131712
SAST 2007-3 (1A & 1M1-1M6) 04/27/07 05/11/07 333-131712
B. DEFENDANTS PARTICIPATION
IN THE SECURITIZATION PROCESS
50. Each of the Defendants, including the Individual Defendants, played a role in the
securitization process and the marketing for some or all of the Certificates purchased by the
GSEs, which included purchasing the mortgage loans from the originators, arranging the
Securitizations, selling the mortgage loans to the depositor, transferring the mortgage loans to the
trustee on behalf of the Certificateholders, underwriting the public offering of the Certificates,
structuring and issuing the Certificates, and marketing and selling the Certificates to Fannie Mae
and Freddie Mac.
51. The Defendants are liable, jointly and severally, as participants in the registration,
issuance and offering of the Certificates purchased by the GSEs, including issuing, causing, or
making materially misleading statements in the Registration Statements, and omitting material
facts required to be stated therein or necessary to make the statements contained therein not
misleading.
23
1. Defendant MS
52. Defendant MS wholly owns Defendants MS&Co., MSAC, MSC and MSMC, and
is the ultimate parent of Defendants SCI, SFM and SASC. The chart below indicates the
corporate structure of the Morgan Stanley Defendants.
53. MS employed its subsidiaries or affiliates, MS&Co., MSAC, MSC, MSMC, SCI,
SFM and SASC to effectuate the securitization process. Unlike typical arms-length transactions,
the Securitizations here involved MS subsidiaries or affiliates at virtually each step in the chain.
For 29 of the 33 Securitizations, MSMC/MCI or SFM served as the sponsor, and MSAC, MSC
or SASC served as the depositor. For 26 of those 29 Securitizations, and the remaining four of
the 33 total Securitizations, MS&Co. was also the selling underwriter.
54. As the corporate parent of MS&Co., MSAC, MSC and MSMC, and the ultimate
parent of SCI, SFM and SASC, MS had the practical ability to direct and control the actions of
MS
MS & Co.
(underwriter)
MSAC
(depositor)
MSC
(depositor)
MSMC
(successor in
interest to MCI)
(sponsor)
SCI
SFM
(f/k/a SFM Inc.)
(sponsor)
SASC
(depositor)
24
these subsidiaries in issuing and selling the Certificates purchased by the GSEs, and in fact
exercised such direction and control over the activities of these entities related to the
Securitizations, and the issuance and sale of the Certificates purchased by the GSEs.
55. As detailed, supra, the Securitizations involved MS-related entities at virtually
each step in the process, and MS profited substantially from this vertically-integrated approach to
mortgage-backed securitization. Furthermore, on information and belief, MS currently shares,
and at all relevant times shared, overlapping management with the other Morgan Stanley entities.
For instance, Defendant Phillips was, at all relevant times, the Global Head of Securitized
Products at MS while also serving as the President and CEO at Defendant MSAC. Similarly,
Defendant Warren was, at all relevant times, the Global Head of Structured Credit Trading at
Defendant MS while also serving as the President and Director at Defendant MSC.
2. Defendant SCI
56. SCI is the corporate parent of SFM and SASC and controlled the business
operations of SFM and SASC. As the corporate parent of SFM and SASC, SCI had the practical
ability to direct and control the actions of SFM and SASC in issuing and selling the Certificates
purchased by the GSEs, and in fact exercised such direction and control over the activities of
SFM and SASC in connection with the issuance and sale of the Certificates purchased by the
GSEs.
3. Defendants MSMC and SFM
57. MSMC was the sponsor of one Securitization. Through a June 17, 2007 merger,
MSMC became the successor-in-interest to MCI, which served as the sponsor of 20 of the
Securitizations. SFM was the sponsor of six of the 33 Securitizations. MSMC and SFM are
referred to herein together as the Sponsors.
25
58. MCI was formed in 1985 as a wholly-owned subsidiary of MS for the sole
purpose of issuing RMBS through its affiliates MSAC and MSC and during the relevant time
period, MCI was a leading sponsor of RMBS in the nation. As stated in the September 28, 2007
Prospectus Supplement for the MSAC 2007-HE7 Securitization, from the period January 2000
through August 2007, MCI securitized residential mortgage loans with an aggregate principal
balance of $116.2 billion, including securitizing residential mortgage loans totaling $11.32
billion in 2003, $27.02 billion in 2004, $23.09 billion in 2005, and $29.99 billion in 2006.
59. As the sponsor of 27 of the 33 Securitizations, MSMC/MCI and SFM determined
the structure of the Securitizations, initiated the Securitizations, purchased the mortgage loans to
be securitized, determined distribution of principal and interest, and provided data to the rating
agencies to secure investment grade ratings for the Certificates purchased by the GSEs.
MSMC/MCI and SFM also selected MSAC, MSC, or SASC as the special-purpose vehicles that
would be used to transfer the mortgage loans from MSMC, MCI or SFM to the trusts, and
selected MS&Co. Credit Suisse, or RBS as the selling underwriter for the Securitizations. In its
role as sponsor, MSMC/MCI and SFM knew and intended that the mortgage loans it purchased
would be sold in connection with the securitization process, and that certificates representing
such loans would be issued by the relevant trusts.
60. For the 27 Securitizations that they sponsored, MSMC/MCI and SFM also
conveyed the mortgage loans to MSAC, MSC, and SASC as depositors, pursuant to an
Assignment and Recognition Agreement or a Mortgage Loan Purchase Agreement. In these
agreements, MSMC/MCI and SFM made certain representations and warranties to MSAC, MSC,
and SFM regarding the groups of loans collateralizing the Certificates purchased by the GSEs.
26
These representations and warranties were assigned by MSAC, MSC, and SFM to the trustees
for the benefit of the Certificateholders.
4. Defendants MSAC, MSC, and SASC
61. MSAC and MSC are wholly-owned subsidiaries of MS, and SASC is a subsidiary
of MS and a wholly-owned subsidiary of SFM. MSAC, MSC and SASC (together, the
Depositors) were all formed as special-purpose entities for the sole purpose of purchasing
mortgage loans, filing registration statements with the SEC, forming issuing trusts, assigning
mortgage loans and all of its rights and interests in such mortgage loans to the trustee for the
benefit of the Certificateholders, and depositing the underlying mortgage loans into the issuing
trusts. MSAC, MSC and SASC were the depositors for 30 of the 33 Securitizations. In their
capacity as depositors, MSAC, MSC and SASC purchased the mortgage loans from MSMC/MCI
and SFM, pursuant to the applicable Assignment and Recognition Agreement or a Mortgage
Loan Purchase Agreement. MSAC, MSC, and SASC then sold, transferred, or otherwise
conveyed the mortgage loans to be securitized to the trusts. Together with the other Defendants,
MSAC, MSC and SASC also were responsible for preparing and filing the Registration
Statements pursuant to which the Certificates purchased by the GSEs were offered for sale. The
trusts, in turn held the mortgage loans for the benefit of the Certificateholders, and issued the
Certificates in public offerings for sale to investors, including Fannie Mae and Freddie Mac.
5. Defendant MS&Co.
62. MS&Co. is a wholly-owned subsidiary of MS. MS&Co. is and was, at all
relevant times, an SEC-registered broker-dealer and one of the leading underwriters of mortgage
and other asset-backed securities in the United States. According to Inside Mortgage Finance,
MS&Co. was the 10
th
largest non-agency RMBS underwriter in 2006, underwriting over $53.9
27
billion of RMBS, and the 8
th
largest RMBS underwriter in 2007, underwriting over $39.9
billion.
7
63. As co-lead underwriter -- and the selling underwriter -- for 30 of the 33
Securitizations MS&Co. was responsible for underwriting and managing the offer and sale of
Certificates to Fannie Mae and Freddie Mac and other investors. MS&Co. was also obligated to
conduct due diligence to ensure that the Registration Statements did not contain any material
misstatements or omissions, including misstatements or omissions concerning the origination,
transfer, and underwriting.
6. Non-MS Defendants
64. Credit Suisse and RBS were among the nations largest non-agency mortgage-
backed securities underwriters between 2004 through 2007. Credit Suisse and RBS were the
selling underwriters for three Securitizations in which SFM was the sponsor and SASC was the
depositor. Credit Suisse and RBS were responsible for underwriting and managing the offer and
sale of Certificates to the GSEs. These underwriter Defendants also were obligated to conduct
due diligence to ensure that the Registration Statements did not contain any material
misstatements or omissions, including as to the manner in which the underlying mortgage loans
were originated, transferred and underwritten.
7. Individual Defendants
65. Each of the Individual Defendants signed at least one of the seven Shelf
Registration Statements and/or the amendments thereto. Because they prepared, signed, filed
and/or used these documents to market and sell Certificates to Fannie Mae and Freddie Mac,
7
Agency mortgage-backed securities are guaranteed by a government agency or
government-sponsored enterprise such as Fannie Mae or Freddie Mac, while non-agency
mortgage-backed securities are issued by banks and financial companies not associated with a
government agency or government sponsored enterprise.
28
each Individual Defendant is directly responsible for misstatements and omissions of material
fact contained in the Registration Statements.
66. Further, certain of the Individual Defendants, through their positions at Morgan
Stanley, including Defendants MS, MSAC, MSC, SCI, and SASC had the practical ability to
direct and control the actions of the Morgan Stanley Defendants and Defendants SCI, SFM, and
SASC in issuing and selling the Certificates, and in fact, exercised such direction and control
over the activities of these entities in connection with the issuance and sale of Certificates to the
GSEs.
67. As alleged supra, many of the Individual Defendants simultaneously held
management positions at MS and MSAC or MSC, or SCI and SASC. For example, during the
relevant period, Ms. McDonnell, and Messrs. Hubler, Phillips, Frank, Warren, Westerfield, and
Stern all simultaneously held management positions at both MS and MSs subsidiaries, MSAC
or MSC, and signed the Registration Statements filed by MSAC or MSC.
C. STATEMENTS IN THE PROSPECTUS SUPPLEMENTS
68. Plaintiff relies for its claims, in part, upon the Registration Statements in their
entirety. Specific representations and warranties in the Registration Statements that form the
basis for the claims herein are set forth for each Securitization in Appendix A hereto.
1. Compliance With Underwriting Guidelines
69. The Prospectus Supplement for each of the Securitizations contained detailed
descriptions of the underwriting guidelines used to originate the mortgage loans included in the
Securitizations. Because payment on, and the value of, the Certificates is based on the cash
flows from the underlying mortgage pool, representations concerning compliance with the stated
underwriting guidelines were material to reasonable investors. Investors, including the GSEs,
29
did not have access to information concerning the collateral pool, and were required to rely on
the representations in the Prospectus Supplements concerning that collateral.
70. Among other consequences, the failure to originate mortgage loans in accordance
with stated guidelines diminishes the value of the Certificates by increasing the risk that an
investor will not be paid its principal and interest. Misrepresentations concerning, or failure
accurately to disclose, borrower, loan and property characteristics bearing on the risk of default
by the borrower as well as the severity of losses given default can artificially inflate the
perceived value of the securities. Without complete and accurate information regarding the
collateral pool, reasonable investors, including the GSEs, are unable accurately and
independently to assess whether the price of an RMBS adequately accounts for the risks they are
assuming when they purchase the security.
71. The Prospectus Supplements for each of the Securitizations contained several key
statements with respect to the loan purchasing and underwriting standards of the entities that
originated the loans in the Securitizations. For example, with respect to the MSAC 2006-HE8
Securitization -- for which MS&Co. was the underwriter, MSAC was the depositor, and New
Century was the originator -- the Prospectus Supplement states:
The mortgage loans will have been originated in accordance with the New
Century Underwriting Guidelines and that [t]he New Century
Underwriting Guidelines are primarily intended to assess the borrowers
ability to repay the mortgage loan, to assess the value of the mortgaged
property and to evaluate the adequacy of the property as collateral for the
mortgage loan. (Emphasis added).
72. With respect to the information evaluated by the originator (in this example, New
Century), the Prospectus Supplement for the MSAC 2006-HE8 Securitization stated that:
Each applicant completes an application which includes information with
respect to the applicants liabilities, income, credit history, employment
history and personal information. The New Century Underwriting
Guidelines require a credit report on each applicant from a credit reporting
30
company. The report typically contains information relating to matters
such as credit history with local and national merchants and lenders,
installment debt payments and any record of defaults, bankruptcies,
repossessions or judgments. (Emphasis added).
73. The Prospectus Supplement for the MSAC 2006-HE8 Securitization further
states:
The New Century Underwriting Guidelines require that mortgage loans be
underwritten in a standardized procedure which complies with applicable
federal and state laws and regulations and requires New Centurys
underwriters to be satisfied that the value of the property being financed,
as indicated by an appraisal and a review of the appraisal, currently
supports the outstanding loan balance.
74. The Prospectus Supplements for each of the Securitizations made similar
representations with respect to the underwriting guidelines employed by each of the originators
in the Securitizations, which included: Aames Capital, Accredited Home, Wilmington,
American Home, Decision One, First National, First NLC, GreenPoint, Hemisphere, New
Century and its subsidiary, Home123, IndyMac, Meritage, MortgageIT, Wachovia, WMC,
MSCC and SMI. See Appendix A.
75. Contrary to those representations, however, these originators routinely and
egregiously departed from, or abandoned completely, their stated underwriting guidelines, as
discussed in Section (I)(D)(2), infra. As a result, the representations concerning compliance with
underwriting guidelines and the inclusion and descriptions of those guidelines in the Prospectus
Supplements were false and misleading, and the actual mortgages underlying each Securitization
exposed the purchasers, including the GSEs, to a materially greater risk to investors than that
represented in the Prospectus Supplements.
76. As reflected more fully in the Appendix, for the vast majority of the
Securitizations, the Prospectus Supplements included representations that: (i) the mortgage loans
were underwritten in accordance with each originators underwriting guidelines in effect at the
31
time of origination, subject only to limited exceptions; and (ii) the origination and collection
practices used by the originator with respect to each mortgage note and mortgage were in all
respects legal, proper and customary in the mortgage origination and servicing business.
77. The inclusion of these representations in the Prospectus Supplements had the
purpose and effect of providing assurances to investors regarding the quality of the mortgage
collateral underlying the Securitizations. These representations were material to a reasonable
investors decisions to purchase the Certificates, and they were material to the GSEs. As alleged
more fully below, Defendants representations were materially false.
2. Occupancy Status of Borrower
78. The Prospectus Supplements for each Securitization set forth information about
the occupancy status of the borrowers of the loans underlying the Securitization; that is, whether
the property securing a mortgage is (i) the borrowers primary residence; (ii) a second home, or
(iii) an investment property. This information was presented in tables, typically titled
Occupancy Status of the Mortgage Loans, that assigned all the properties in the collateral
group to one of the following categories: (i) Primary, or Owner-Occupied; (ii) Second
Home, or Secondary; and (iii) Investor or Non-Owner. For each category, the table
stated the number of loans purportedly in that category. Occupancy statistics for the Supporting
Loan Groups for each Securitization were reported in the Prospectus Supplements as follows:
8
Table 4
Transaction
Supporting
Loan Group
Primary or
Owner-Occupied
Second Home /
Secondary
Investor
AMIT 2005-4 Group I 94.48% 0.88% 4.64%
MSAC 2005-HE5 Group I 94.14% 2.58% 3.28%
8
Each Prospectus Supplement provides the total number of loans and the number of loans
in the following categories: owner-occupied, investor, and second home. These numbers have
been converted to percentages for ease of comparison.
32
Transaction
Supporting
Loan Group
Primary or
Owner-Occupied
Second Home /
Secondary
Investor
MSAC 2005-HE6 Group I 92.66% 1.02% 6.32%
MSAC 2006-HE3 Group I 94.93% 0.64% 4.43%
MSAC 2006-HE5 Group I 95.02% 0.73% 4.25%
MSAC 2006-HE6 Group I 87.61% 4.01% 8.38%
MSAC 2006-HE8 Group I 92.06% 1.02% 6.92%
MSC 2006-NC2 Group I 86.31% 3.94% 9.75%
MSAC 2006-NC3 Group I 83.30% 3.03% 13.67%
MSAC 2006-NC4 Group I 87.40% 3.79% 8.81%
MSAC 2006-WMC2 Group I 93.64% 4.24% 2.12%
MSAC 2007-HE1 Group I 84.76% 2.68% 12.56%
MSAC 2007-HE5 Group I 96.87% 1.50% 1.63%
MSAC 2007-HE7 Group I 88.98% 1.35% 9.67%
MSAC 2007-NC1 Group I 84.87% 4.46% 10.67%
MSC 2006-HE2 Group I 97.59% 0.82% 1.59%
MSHEL 2005-4 Group I 96.17% 0.96% 2.87%
MSM 2005-10 Group 3 100.00% 0.00% 0.00%
MSM 2005-7 Group 5 100.00% 0.00% 0.00%
MSM 2006-16AX Group 1 53.46% 5.72% 40.82%
MSM 2006-2 (7A1 & A2) Group 7 100.00% 0.00% 0.00%
MSM 2007-2AX Group 1 44.72% 8.31% 46.97%
MSM 2007-5AX Group 1 54.19% 6.29% 39.52%
MSM 2007-7AX Group 1 68.30% 5.14% 26.56%
NCHET 2005-B Group I 85.20% 4.59% 10.21%
NCHET 2005-C Group I 83.31% 2.75% 13.94%
NCHET 2005-D Group I 86.02% 3.50% 10.49%
SAST 2005-3 Group 1 96.50% 0.46% 3.03%
SAST 2006-1 Group 1 94.53% 1.18% 4.30%
SAST 2006-2 Group 2 91.88% 0.70% 7.42%
SAST 2006-2 Group 1 94.07% 0.35% 5.58%
SAST 2007-1 Group 1 92.83% 0.66% 6.51%
SAST 2007-2 Group 1 91.53% 0.30% 8.17%
SAST 2007-3 (1A & 1M1-1M6) Group 1 90.37% 0.97% 8.66%
79. As Table 4 makes clear, the Prospectus Supplements reported that 30 of the 34
Supporting Loan Groups contained at least 80 percent owner-occupied loans, and 20 of the 34
Supporting Loan Groups contained at least 90 percent owner-occupied loans.
80. Because information about occupancy status is an important factor in determining
the credit risk associated with a mortgage loan -- and, therefore, the securitization that it backs --
the statements in the Prospectus Supplements concerning occupancy status were material to a
reasonable investors decision to invest in the Certificates, and they were material to the GSEs.
33
These statements were material because, among other reasons, borrowers who live in mortgaged
properties are substantially less likely to default and more likely to care for their primary
residence than borrowers who purchase properties as second homes or investments and live
elsewhere. For example, as stated in the Prospectus Supplement for the SAST 2006-1
Securitization and other Securitizations: Mortgage loans secured by properties acquired by
investors for the purpose of rental income or capital appreciation, or properties acquired as
second homes, tend to have higher severities of default than properties that are regularly
occupied by the related borrowers. Accordingly, the percentage of loans in the collateral group
of a securitization that are secured by mortgage loans on owner-occupied residences is an
important measure of the risk of the certificates sold in that securitization.
81. Other things being equal, the lower the percentage of loans secured by owner-
occupied residences, the greater the risk of loss to Certificateholders. Even modest differences in
the percentages of primary/owner-occupied, second home/secondary, and investment properties
in the collateral group of a securitization can have a significant effect on the risk of each
certificate sold in that securitization, and thus, are important to the decision of a reasonable
investor whether to purchase any such certificate. As discussed infra at paragraphs 94 through
97, the Prospectus Supplements for each Securitization materially overstated the percentage of
loans in the Supporting Loan Groups that were owner-occupied, thereby misrepresenting the
degree of risk of the Certificates purchased by the GSEs.
3. Loan-to-Value Ratios
82. The loan-to-value ratio of a mortgage loan, or LTV ratio, is the ratio of the
balance of the mortgage loan to the value of the mortgaged property when the loan is made.
83. The denominator in the LTV ratio is the value of the mortgaged property, and is
generally the lower of the purchase price or the appraised value of the property. In a refinancing
34
or home-equity loan, there is no purchase price to use as the denominator, so the denominator is
often equal to the appraised value at the time of the origination of the refinanced loan or home-
equity loan. Accordingly, an accurate appraisal is essential to an accurate LTV ratio. In
particular, an inflated appraisal will understate, sometimes greatly, the credit risks associated
with a given loan.
84. The Prospectus Supplements for the Securitizations contain information about the
LTV ratio for each Supporting Loan Group. Table 5 below reflects two categories of important
information reported in the Prospectus Supplements concerning the LTV ratios for each
Supporting Loan Group: (i) the percentage of loans with an LTV ratio of 80 percent or less; and
(ii) the percentage of loans with an LTV ratio greater than 100 percent.
9
Table 5
Transaction
Supporting
Loan Group
Percentage of loans, by
aggregate principal
balance, with LTV less
than or equal to 80%
Percentage of loans, by
aggregate principal
balance, with LTV
greater than 100%
AMIT 2005-4 Group I 77.40% 0.00%
MSAC 2005-HE5 Group I 59.42% 0.00%
MSAC 2005-HE6 Group I 64.31% 0.00%
MSAC 2006-HE3 Group I 60.73% 0.00%
MSAC 2006-HE5 Group I 51.21% 0.00%
MSAC 2006-HE6 Group I 62.20% 0.00%
MSAC 2006-HE8 Group I 56.24% 0.00%
MSC 2006-NC2 Group 1 57.13% 0.00%
MSAC 2006-NC3 Group I 53.43% 0.00%
MSAC 2006-NC4 Group I 60.48% 0.00%
MSAC 2006-WMC2 Group I 70.46% 0.00%
MSAC 2007-HE1 Group I 52.24% 0.00%
9
As used in this Complaint, LTV refers to the loan-to-value ratio for first lien mortgages
and for properties with second liens subordinate to the lien included in the securitization (i.e.,
only the securitized lien is included in the numerator of the LTV calculation). Where the
securitized lien is junior to another loan, the more senior lien has been added to the securitized
one to determine the numerator in the LTV calculation (this latter calculation is sometimes
referred to as the combined-loan-to-value ratio, or CLTV).
35
Transaction
Supporting
Loan Group
Percentage of loans, by
aggregate principal
balance, with LTV less
than or equal to 80%
Percentage of loans, by
aggregate principal
balance, with LTV
greater than 100%
MSAC 2007-HE5 Group I 54.79% 0.00%
MSAC 2007-HE7 Group I 51.48% 0.00%
MSAC 2007-NC1 Group I 56.89% 0.00%
MSC 2006-HE2 Group I 66.14% 0.00%
MSHEL 2005-4 Group I 59.99% 0.00%
MSM 2005-10 Group 3 97.71% 0.00%
MSM 2005-7 Group 5 97.49% 0.00%
MSM 2006-16AX Group 1 92.54% 0.00%
MSM 2006-2 (7A1 & A2) Group 7 95.03% 0.00%
MSM 2007-2AX Group 1 96.65% 0.00%
MSM 2007-5AX Group 1 90.17% 0.00%
MSM 2007-7AX Group 1 83.36% 0.00%
NCHET 2005-B Group I 61.84% 0.00%
NCHET 2005-C Group I 54.64% 0.00%
NCHET 2005-D Group I 58.60% 0.00%
SAST 2005-3 Group 1 57.66% 0.00%
SAST 2006-1 Group 1 59.06% 0.00%
SAST 2006-2 Group 2 61.06% 0.00%
SAST 2006-2 Group 1 61.77% 0.00%
SAST 2007-1 Group 1 54.21% 0.00%
SAST 2007-2 Group 1 45.15% 0.00%
SAST 2007-3 (1A & 1M1-1M6) Group 1 53.38% 0.00%
85. The LTV ratio is among the most important measures of the risk of a mortgage
loan for several reasons. First, the LTV ratio is a strong indicator of the likelihood of default,
because a higher LTV ratio makes it more likely that a decline in the value of a property will
completely eliminate a borrowers equity, and will incentivize the borrower to stop making
mortgage payments and abandon the property. Second, the LTV ratio is a strong predictor of the
severity of loss in the event of a default because the higher the LTV ratio, the smaller the equity
cushion, and the greater the likelihood that the proceeds of foreclosure will not cover the unpaid
balance of the mortgage loan.
36
86. Thus, the LTV ratios were material to a reasonable investors investment decision
with respect to the Certificates, and they were material to the GSEs. Even small differences
between the LTV ratios of the mortgage loans in the collateral group of a securitization have a
significant effect on the likelihood that collateral groups will generate sufficient funds to pay
certificateholders in that securitization. Such differences are important to the decision of a
reasonable investor on whether to purchase any such certificate, and they affect the intrinsic
value of the certificate.
87. As Table 5 makes clear, the Prospectus Supplements for all of the Securitizations
reported that the majority of the mortgage loans in the Supporting Loan Groups had an LTV ratio
of 80 percent or less. The Prospectus Supplements also reported that none of the Supporting
Loan Groups contained a single loan with an LTV ratio over 100 percent.
88. As discussed infra at paragraphs 98 through 103, the Prospectus Supplements for
the Securitizations materially overstated the percentage of loans in the Supporting Loan Groups
with an LTV ratio at or less than 80 percent, and materially understated the percentage of loans
in the Supporting Loan Groups with an LTV ratio over 100 percent, thereby misrepresenting the
degree of risk to Certificateholders.
4. Credit Ratings
89. Credit ratings are assigned to the tranches of mortgage-backed securitizations by
the credit rating agencies, including Standard & Poors, Moodys Investors Service, and Fitch
Ratings. Each credit rating agency uses its own scale with letter designations to describe various
levels of risk. In general, AAA or its equivalent ratings are at the top of the credit rating scale
and are intended to designate the safest investments. C and D ratings are at the bottom of the
scale and refer to investments that are currently in default and exhibit little or no prospect for
recovery. At the time Fannie Mae and Freddie Mac purchased the Certificates, investments with
37
AAA or its equivalent ratings historically experienced a loss rate of less than .05 percent.
Investments with a BBB rating, or its equivalent, historically experienced a loss rate of less than
one percent. As a result, securities with credit ratings between AAA or its equivalent through
BBB- or its equivalent were generally referred to as investment grade.
90. Rating agencies determine the credit rating for each tranche of a mortgage-backed
securitization by comparing the likelihood of contractual principal and interest repayment to the
credit enhancements available to protect investors. Rating agencies determine the likelihood
of repayment by estimating cash flows based on the quality of the underlying mortgages by using
sponsor-provided loan-level data. Credit enhancements, such as subordination, represent the
amount of cushion or protection from loss incorporated into a given securitization.
10
This
cushion is intended to improve the likelihood that holders of highly-rated certificates receive the
interest and principal to which they are contractually entitled. The level of credit enhancement
offered is based on the composition of the loans in the underlying collateral group and entire
securitization. Riskier loans underlying the securitization necessitate higher levels of credit
enhancement to insure payment to senior certificate holders. If the collateral within the deal is of
a higher quality, then rating agencies require less credit enhancement for an AAA or its
equivalent rating.
91. For almost a hundred years, investors like pension funds, municipalities,
insurance companies, and university endowments have relied heavily on credit ratings to assist
them in distinguishing between safe and risky investments.
10
Subordination refers to the fact that the certificates for a mortgage-backed
securitization are issued in a hierarchical structure, from senior to junior. The junior certificates
are subordinate to the senior certificates in that, should the underlying mortgage loans become
delinquent or default, the junior certificates suffer losses first. These subordinate certificates
thus provide a degree of protection to the senior certificates from certain losses on the underlying
loans.
38
92. Each tranche of the Securitizations received a credit rating before issuance, which
purported to describe the riskiness of that tranche. Defendants reported the credit ratings for
each tranche in the Prospectus Supplements. For each of the Certificates purchased by the GSEs
the credit rating provided was virtually always AAA or its equivalent.
11
The accuracy of these
ratings was material to a reasonable investors decision to purchase the Certificates, and it was
material to the GSEs. Among other things, the ratings provided additional assurance that
investors in the Certificates would receive the expected interest and principal payments. As set
forth in Table 8, infra at paragraph 125, the ratings for most of the Securitizations were severely
downgraded to well below investment grade after the GSEs purchase of the Certificates.
Upon information and belief, the initial ratings were based in substantial part upon the materially
inaccurate and incomplete information in the Registration Statements and related information
provided to the ratings agencies.
D. FALSITY OF STATEMENTS IN THE REGISTRATION STATEMENTS
AND PROSPECTUS SUPPLEMENTS
1. The Statistical Data Provided in the Prospectus Supplements
Concerning Owner-Occupancy and Loan-To-Value Ratios Was
Materially False
93. A review of loan-level data was conducted to assess whether the statistical
information provided in the Prospectus Supplements was true and accurate. For each
Securitization, the review included an analysis either of: (i) a sample of 1,000 loans randomly
selected from the Supporting Loan Group; or (ii) all the loans in the Supporting Loan Group, if
there were fewer than 1,000 such loans. The review of sample data has confirmed, on a
statistically-significant basis, that the data provided in the Prospectus Supplements concerning
11
With the exception of six tranches of SAST 2007-3 Certificates, as noted in Table 8 infra,
all of which were rated higher than A3/A-/A.
39
owner-occupancy and LTV ratios was materially false, and that the Prospectus Supplements
contained material misrepresentations with respect to the underwriting standards employed by
the originators, and certain key characteristics of the mortgage loans across the Securitizations.
a. Owner-Occupancy Data was Materially False
94. The data review has revealed that the owner-occupancy statistics reported in the
Prospectus Supplements were materially false and inflated. Indeed, the Prospectus Supplements
over-reported the number of underlying properties that were occupied by their owners, and
underreported the number of underlying properties held as second homes or investment
properties.
95. To determine whether a given borrower actually occupied the property as
claimed, a number of tests were conducted, including, inter alia, whether, months after the loan
closed, the borrowers tax bill was being mailed to the property or to a different address, whether
the borrower had claimed a tax exemption on the property, and whether the mailing address of
the property was reflected in the borrowers credit reports, tax records, or lien records. Failing
two or more of these tests constitutes strong evidence that the borrower did not live at the
mortgaged property and instead used it as a second home or an investment property, rendering it
much more likely that a borrower will not repay the loan.
96. For each Securitization, a significant number of the underlying loans failed two or
more of these tests, indicating that the owner-occupancy statistics provided to investors, such as
Fannie Mae and Freddie Mac, were materially false and misleading. For example, the
Prospectus Supplement for the MSAC 2006-HE8 Securitization -- for which MCI was the
sponsor and MS&Co. was the underwriter -- stated that 7.94 percent of the underlying properties
by loan count in the Supporting Loan Group were second homes or investment properties. But
the data review revealed that the true percentage of non-owner-occupied properties was 20.19
40
percent,
12
over 250 percent greater than the percentage reported in the Prospectus Supplement
because for 13.3 percent of the properties represented as owner-occupied, the owners lived
elsewhere
97. The data review revealed that for each Securitization, the Prospectus Supplement
misrepresented the percentage of non-owner-occupied properties. The true percentage of non-
owner-occupied properties, as determined by the data review, versus the percentage stated in the
Prospectus Supplement for each Securitization, is reflected in Table 6 below. Table 6
demonstrates that the Prospectus Supplements for each Securitization significantly understated
the percentage of non-owner-occupied properties.
Table 6
A B C D
Transaction
Supporting
Loan
Group
Reported
Percentage of
Non-Owner-
Occupied
Properties
% of Properties
Reported as
Owner-Occupied
in the Offering
Materials with
Strong Indication
of Non-Owner-
Occupancy
Actual
Percentage of
Non-Owner-
Occupied
Properties
Understatement
of Non-Owner-
Occupied
Properties in
the Offering
Materials
AMIT 2005-4 Group I 5.52% 8.66% 13.70% 8.18%
MSAC 2005-HE5 Group I 5.86% 14.38% 19.40% 13.54%
MSAC 2005-HE6 Group I 7.34% 11.66% 18.15% 10.81%
MSAC 2006-HE3 Group I 5.07% 13.12% 17.53% 12.46%
MSAC 2006-HE5 Group I 4.98% 11.80% 16.19% 11.21%
MSAC 2006-HE6 Group I 12.39% 11.58% 22.54% 10.15%
MSAC 2006-HE8 Group I 7.94% 13.30% 20.19% 12.25%
MSC 2006-NC2 Group I 13.69% 11.03% 23.21% 9.52%
MSAC 2006-NC3 Group I 16.70% 11.11% 25.95% 9.25%
MSAC 2006-NC4 Group I 12.60% 10.07% 21.40% 8.80%
MSAC 2006-WMC2 Group I 6.36% 12.49% 18.05% 11.69%
MSAC 2007-HE1 Group I 15.24% 8.66% 22.59% 7.35%
MSAC 2007-HE5 Group I 3.13% 10.60% 13.40% 10.27%
MSAC 2007-HE7 Group I 11.02% 12.02% 21.71% 10.69%
MSAC 2007-NC1 Group I 15.13% 9.48% 23.18% 8.05%
12
The true percentage of non-owner-occupied properties (Table 6 Column C) is calculated
by adding the percentage reported in the Prospectus Supplement (Table 6 Column A) to the
product of owner-occupied properties reported in the Prospectus Supplement (100 minus
Column A) and the percentage of properties reported as owner-occupied but with strong
indication of non-owner occupancy (Table 6 Column B).
41
A B C D
Transaction
Supporting
Loan
Group
Reported
Percentage of
Non-Owner-
Occupied
Properties
% of Properties
Reported as
Owner-Occupied
in the Offering
Materials with
Strong Indication
of Non-Owner-
Occupancy
Actual
Percentage of
Non-Owner-
Occupied
Properties
Understatement
of Non-Owner-
Occupied
Properties in
the Offering
Materials
MSC 2006-HE2 Group I 2.41% 11.74% 13.86% 11.45%
MSHEL 2005-4 Group I 3.83% 11.54% 14.93% 11.10%
MSM 2005-10 Group 3 0.00% 14.35% 14.35% 14.35%
MSM 2005-7 Group 5 0.00% 11.45% 11.45% 11.45%
MSM 2006-16AX Group 1 46.54% 14.03% 54.04% 7.50%
MSM 2006-2 (7A1 & 7A2) Group 7 0.00% 15.15% 15.15% 15.15%
MSM 2007-2AX Group 1 55.28% 14.03% 61.55% 6.27%
MSM 2007-5AX Group 1 45.81% 14.23% 53.52% 7.71%
MSM 2007-7AX Group 1 31.70% 13.82% 41.14% 9.44%
NCHET 2005-B Group I 14.80% 13.09% 25.95% 11.15%
NCHET 2005-C Group I 16.69% 12.12% 26.78% 10.09%
NCHET 2005-D Group I 13.98% 11.80% 24.14% 10.16%
SAST 2005-3 Group 1 3.50% 8.81% 12.00% 8.50%
SAST 2006-1 Group 1 5.47% 9.92% 14.85% 9.38%
SAST 2006-2 Group 2 8.12% 10.93% 18.16% 10.04%
SAST 2006-2 Group 1 5.93% 8.73% 14.14% 8.21%
SAST 2007-1 Group 1 7.17% 10.74% 17.14% 9.97%
SAST 2007-2 Group 1 8.46% 9.32% 16.99% 8.53%
SAST 2007-3 (1A & 1M1-1M6) Group 1 9.63% 9.66% 18.36% 8.73%
b. Loan-to-Value Data was Materially False
98. The data review has further revealed that the LTV ratios disclosed in the
Prospectus Supplements were materially false and understated, as more specifically set out
below. For each of the sampled loans, an industry standard automated valuation model
(AVM) was used to calculate the value of the underlying property at the time the mortgage
loan was originated. AVMs are routinely used in the industry as a way of valuing properties
during prequalification, origination, portfolio review, and servicing. AVMs rely upon similar
data as appraisers -- primarily county assessor records, tax rolls, and data on comparable
properties. AVMs produce independent, statistically-derived valuation estimates by applying
modeling techniques to this data.
42
99. Applying the AVM to the available data for the properties securing the sampled
loans shows that the retroactive appraised value given to such properties was significantly higher
than the actual value of such properties. The result of this overstatement of property values is a
material understatement of LTV. That is, if a propertys true value is significantly less than the
value used in the loan underwriting, then the loan represents a significantly higher percentage of
the propertys value. This, of course, increases the risk a borrower will not repay the loan and
the risk of greater losses in the event of a default. As stated in the Prospectus Supplement for
MSAC 2006-HE8: Mortgage loans with higher loan-to-value ratios may present a greater risk
of loss than mortgage loans with loan-to-value ratios of 80 percent or below.
100. For example, for the MSAC 2007-HE5 Securitization, which was sponsored by
MCI and underwritten by MS&Co., the Prospectus Supplement stated that no LTV ratios for the
Supporting Loan Group were above 100 percent. In fact, 31.13 percent of the sample of loans
included in the data review had LTV ratios above 100 percent; that is, mortgage loans with no
equity cushion whatsoever. The Prospectus Supplement for the MSAC 2007-HE5 Securitization
contained equally false statements with respect to the percentage of loans with an equity cushion
of 20 percent or more. Specifically, whereas the Prospectus Supplement stated that 54.79
percent of the loans had LTV ratios at or below 80 percent, the data review indicated that only
28.12 percent of the loans had LTV ratios at or below 80 percent.
101. The data review revealed that for each Securitization, the Prospectus Supplement
misrepresented the percentage of loans with an LTV ratio that were above 100 percent, as well
the percentage of loans that had an LTV ratio at or below 80 percent. Table 7 reflects (i) the true
percentage of mortgages in the Supporting Loan Group with LTV ratios above 100 percent,
versus the percentage reported in the Prospectus Supplement; and (ii) the true percentage of
43
mortgages in the Supporting Loan Group with LTV ratios at or below 80 percent, versus the
percentage reported in the Prospectus Supplement. The percentages listed in Table 7 were
calculated by aggregated principal balance.
Table 7
PROSPECTUS DATA REVIEW PROSEPCTUS
DATA
REVIEW
Transaction
Supporting
Loan
Group
Percentage of
Loans reported
to Have LTV
Ratio at or Less
than 80%
True Percentage
of Loans with
LTV Ratio at or
Less than 80%
Percentage of
Loans Reported
to have LTV
Ratio Over
100%
True
Percentage of
Loans with
LTV Ratio
Over 100%
AMIT 2005-4 Group I 77.40% 46.39% 0.00% 7.82%
MSAC 2005-HE5 Group I 59.42% 41.78% 0.00% 12.07%
MSAC 2005-HE6 Group I 64.31% 49.07% 0.00% 11.96%
MSAC 2006-HE3 Group I 60.73% 43.14% 0.00% 12.10%
MSAC 2006-HE5 Group I 51.21% 32.43% 0.00% 21.00%
MSAC 2006-HE6 Group I 62.20% 40.66% 0.00% 18.89%
MSAC 2006-HE8 Group I 56.24% 36.37% 0.00% 22.65%
MSC 2006-NC2 Group I 57.13% 42.29% 0.00% 15.57%
MSAC 2006-NC3 Group I 53.43% 41.33% 0.00% 17.45%
MSAC 2006-NC4 Group I 60.48% 42.18% 0.00% 14.01%
MSAC 2006-WMC2 Group I 70.46% 38.82% 0.00% 16.08%
MSAC 2007-HE1 Group I 52.24% 32.48% 0.00% 19.28%
MSAC 2007-HE5 Group I 54.79% 28.12% 0.00% 31.13%
MSAC 2007-HE7 Group I 51.48% 32.73% 0.00% 22.18%
MSAC 2007-NC1 Group I 56.89% 33.41% 0.00% 20.12%
MSC 2006-HE2 Group I 66.14% 41.00% 0.00% 16.50%
MSHEL 2005-4 Group I 59.99% 40.31% 0.00% 12.66%
MSM 2005-10 Group 3 97.71% 64.07% 0.00% 3.12%
MSM 2005-7 Group 5 97.49% 56.49% 0.00% 3.46%
MSM 2006-16AX Group 1 92.54% 51.38% 0.00% 8.29%
MSM 2006-2 (7A1 & 7A2) Group 7 95.03% 57.69% 0.00% 1.11%
MSM 2007-2AX Group 1 96.65% 57.18% 0.00% 10.50%
MSM 2007-5AX Group 1 90.17% 45.69% 0.00% 12.77%
MSM 2007-7AX Group 1 83.36% 46.71% 0.00% 15.20%
NCHET 2005-B Group I 61.84% 41.58% 0.00% 11.73%
NCHET 2005-C Group I 54.64% 42.36% 0.00% 13.73%
NCHET 2005-D Group I 58.60% 44.33% 0.00% 12.71%
SAST 2005-3 Group 1 57.66% 46.69% 0.00% 13.95%
SAST 2006-1 Group 1 59.06% 42.54% 0.00% 15.46%
SAST 2006-2 Group 2 61.06% 42.29% 0.00% 17.07%
SAST 2006-2 Group 1 61.77% 40.62% 0.00% 17.03%
SAST 2007-1 Group 1 54.21% 36.30% 0.00% 21.96%
SAST 2007-2 Group 1 45.15% 27.43% 0.00% 31.79%
SAST 2007-3 (1A & 1M1-1M6) Group 1 53.38% 35.17% 0.00% 27.46%
44
102. As Table 7 demonstrates, the Prospectus Supplements for all of the
Securitizations falsely reported that none of the mortgage loans in the Supporting Loan Groups
had an LTV ratio over 100 percent: the data review revealed that: (i) for 29 of the 34
Supporting Loan Groups, at least 10 percent of the loans had an LTV ratio over 100 percent; and
(ii) for 18 of the 33 Supporting Loan Groups, at least 15 percent of the loans had an LTV ratio
over 100 percent.
103. These misrepresentations with respect to reported LTV ratios also demonstrate
that the representations in the Registration Statements relating to appraisal practices were false,
and that the appraisers, in many instances, furnished appraisals that they understood were
inaccurate and that they knew bore no reasonable relationship to the actual value of the
underlying properties. Indeed, independent appraisers following proper practices, and providing
genuine estimates as to valuation, would not systematically generate appraisals that deviate so
significantly (and so consistently upward) from the true values of the appraised properties. The
Financial Crisis Inquiry Commission (FCIC), created by Congress to investigate the mortgage
crisis and attendant financial collapse in 2008, identified inflated appraisals as a pervasive
problem during the period of the Securitizations, and determined through its investigation that
appraisers were often pressured by mortgage originators, among others, to produce inflated
results. (See Financial Crisis Inquiry Commission, Final Report of the National Commission on
the Causes of the Financial and Economic Crisis in the United States (2011) (FCIC Report), at
91.)
2. The Originators of the Underlying Mortgage Loans Systematically
Disregarded Their Underwriting Guidelines
104. The Prospectus Supplements each contained numerous material misstatements
and omissions concerning the underwriting guidelines used by the originators of the loans
45
included in the Securitizations, defined herein as the Non-Party Originators. Among other
things, the Prospectus Supplements stated that the Non-Party Originators underwrote all loans in
compliance with their respective underwriting guidelines. See Appendix A, Sections I-XXXIII
at Subsections B. These statements were materially false.
105. The Non-Party Originators -- companies such as New Century, WMC, Decision
One, and others -- systematically disregarded their respective underwriting guidelines, as
confirmed not only by the pervasively false owner-occupancy and LTV figures alleged supra,
but also by: (1) government investigations and private actions relating to their underwriting
practices, which have revealed widespread abandonment of their reported underwriting
guidelines during the period of the Securitizations; (2) the collapse of the credit ratings of
Certificates purchased by the GSEs; and (3) the surge in delinquencies and defaults in the
mortgages in the Securitizations.
a. Government and Private Investigations Confirm That the
Originators of the Loans in the Securitizations Systematically
Failed to Adhere to Their Underwriting Guidelines
106. An extraordinary volume of publicly-available information, including government
reports and investigations, confirms that the originators whose loans were included by the
Defendants in the Securitizations abandoned their loan origination guidelines throughout the
period of the Securitizations.
107. For example, in November 2008, the Office of the Comptroller of the Currency
(OCC), an office within the United States Department of the Treasury, issued a report
identifying the Worst Ten mortgage originators in the Worst Ten metropolitan areas. The
worst originators were defined as those with the largest number of non-prime mortgage
foreclosures for 2005-2007 originations. New Century, WMC, IndyMac, Decision One,
GreenPoint and American Home -- the companies that originated the loans for two-thirds of the
46
Securitizations at issue here -- were all on that list. See Worst Ten in the Worst Ten, Office of
the Comptroller of the Currency Press Release. November 13, 2008. Several of the Non-Party
Originators -- including New Century, WMC, IndyMac, and Wilmington -- have been the target
of government investigations or private actions that allege a complete abandonment of their
reported underwriting guidelines.
i. New Century Violated Its Underwriting Guidelines
108. New Century and its subsidiary, Home123, originated loans for at least 14 of the
33 Securitizations. As stated in the Prospectus Supplement for the 2007-NC1 Securitization,
[f]or the nine months ending September 20, 2006, New Century Financial Corporation
originated $45.4 billion in mortgage loans. By the end of 2006, New Century was the third
largest subprime mortgage loan originator in the United States, with a loan production volume
that year of $51.6 billion. And before its collapse in the first half of 2007, New Century was one
of the largest subprime lenders in the country. New Century filed for protection from its
creditors under Chapter 11 of the federal Bankruptcy Code on April 2, 2007.
109. In 2010, the OCC identified New Century as the worst subprime lender in the
country based on the delinquency rates of the mortgages it originated in the 10 metropolitan
areas between 2005 and 2007 with the highest rates of delinquency. See Worst Ten in the
Worst Ten: Update, Office of the Comptroller of Currency Press Release, March 22, 2010.
Further, in January 2011, the FCIC Report detailed, among other things, the collapse of mortgage
underwriting standards and subsequent collapse of the mortgage market and wider economy. See
FCIC Report. The FCIC Report singled out New Century for its role:
New Centuryonce the nations second-largest subprime lenderignored
early warnings that its own loan quality was deteriorating and stripped
power from two risk-control departments that had noted the evidence. In a
June 2004 presentation, the Quality Assurance staff reported they had
found severe underwriting errors, including evidence of predatory lending,
47
federal and state violations, and credit issues, in 25% of the loans they
audited in November and December 2003. In 2004, Chief Operating
Officer and later CEO Brad Morrice recommended these results be
removed from the statistical tools used to track loan performance, and in
2005, the department was dissolved and its personnel terminated. The
same year, the Internal Audit department identified numerous deficiencies
in loan files; out of nine reviews it conducted in 2005, it gave the
companys loan production department unsatisfactory ratings seven
times. Patrick Flanagan, president of New Centurys mortgage-originating
subsidiary, cut the departments budget, saying in a memo that the group
was out of control and tries to dictate business practices instead of audit.
110. On February 29, 2008, after an extensive document review and conducting over
100 interviews, Michael J. Missal, the Bankruptcy Court Examiner for New Century, issued a
detailed report on the various deficiencies at New Century, including lax mortgage standards and
a failure to follow its own underwriting guidelines. Among his findings, the Examiner reported:
New Century had a brazen obsession with increasing loan originations
without due regard for the risks associated with that business strategy. . . .
Although the primary goal of any mortgage banking company is to make
more loans, New Century did so in an aggressive manner that elevated the
risks to dangerous and ultimately to fatal levels.
New Century also made frequent exceptions to its underwriting guidelines
for borrowers who might not otherwise qualify for a particular loan. A
Senior Officer of New Century warned in 2004 that the number one issue
is exceptions to the guidelines. Moreover, many of the appraisals used to
value the homes that secured the mortgages had deficiencies.
New Century . . . layered the risks of loan products upon the risks of loose
underwriting standards in its loan originations to high risk borrowers.
Final Report of Michael J. Missal, Bankruptcy Examiner, In re New Century TRS Holdings, Inc.,
No. 07-10416 (KJC) (Bankr. Del. Feb. 29, 2008).
111. On December 9, 2009, the SEC charged three of New Centurys top officers with
violations of federal securities laws. The SECs complaint details the falsity of New Centurys
representations regarding its underwriting guidelines -- for example, its representations that it
was committed to adher[ing] to high origination standards in order to sell [its] loan products in
48
the secondary market and to only approv[ing] subprime loan applications that evidence a
borrowers ability to repay the loan.
112. New Centurys failure to adhere to its underwriting guidelines is further reflected
in allegations made by the Attorney General of Massachusetts in In re: Morgan Stanley & Co.
Inc., Civil Action No. 10-2538 (Suffolk Cnty. Super. Ct. June 24, 2010). The Massachusetts
Attorney General alleged in his Assurance of Discontinuance that:
New Centurys stretch[ed] underwriting guidelines to encompass or approve
loans not written in accordance with the guidelines. (Id. 17, 23.)
One recurring issue identified by Morgan Stanley was New Centurys
origination of loans that violated Massachusetts Division of Banks borrowers
best interest standard []. (Id. 18.)
During the period 2006-2007, 91 percent of the loans approved for securitization
that did not meet New Centurys underwriting guidelines did not have sufficient
compensating factors to offset such exceptions. (Id. 27.)
In the last three quarters of 2006, Morgan Stanley waived more than half of all
material exceptions found by Clayton . . ., and purchased a substantial number of
New Century loans found by Clayton to violate guidelines without sufficient
compensating factors. (Id. 28.
The loans originated by New Century were unfair loans to Massachusetts
borrowers and were in violation of Massachusetts law . . . . (Id. 43-44.)
113. In settlement of the Massachusetts Attorney Generals charges, on or about June
24, 2010, Morgan Stanley agreed to drastic changes in its underwriting practices and paid $102
million.
114. Patricia Lindsay, a former Vice President of Corporate Risk at New Century,
testified before the FCIC in April 2010 that, beginning in 2004, underwriting guidelines had been
all but abandoned at New Century. Ms. Lindsay further testified that New Century
systematically approved loans with 100 percent financing to borrowers with extremely low credit
scores and no supporting proof of income. (See Written Testimony of Patricia Lindsay for the
49
FCIC Hearing, April 7, 2010 (Lindsay Testimony), http://fcic-static.law.stanford.edu/cdn-
media/fcic.testimony/2010-0407-Lindsay.pdf, at 3.)
115. Ms. Lindsay also testified that appraisers fear[ed] for their livelihoods, and
therefore cherry-picked data that would help support the needed value rather than finding the
best comparables to come up with the most accurate value. (See Written Testimony of Patricia
Lindsay to the FCIC, April 7, 2010, at 5.) Indeed, on May 7, 2007, The Washington Post
reported that a former New Century appraiser, Maggie Hardiman, recounted how she didnt
want to turn away a loan because all hell would break loose and that when she did reject a loan,
her bosses often overruled her and found another appraiser to sign off on it. (David Cho,
Pressure at Mortgage Firm Led to Mass Approval of Bad Loans, The Washington Post (May 7,
2007).)
ii. WMC Violated Its Underwriting Guidelines
116. WMC, which originated the loans for nine of the 33 Securitizations, employed
reckless underwriting standards and practices, as described more fully below, that resulted in a
huge number of foreclosures, ranking WMC fourth in the report presented to the FCIC in April
2010 identifying the Worst Ten mortgage originators in the Worst Ten metropolitan areas.
(See Worst Ten in the Worst Ten, Office of the Comptroller of the Currency Press Release,
November 13, 2008.) General Electric, which had purchased WMC in 2004, closed down
operations at WMC in late 2007 and took a $1.4 billion charge in the third quarter of that year.
(See, e.g., Diane Brady, Adventures of a Subprime Survivor, Bloomberg Businessweek, Oct. 29,
2007 (available at http://www.businessweek.com/magazine/content/07_44/b4056074.htm).)
117. WMCs reckless loan originating practices were noticed by regulatory authorities.
In June 2008, the Washington State Department of Financial Institutions, Division of Consumer
Services filed a Statement of Charges and Notice of Intention to Enter an Order to Revoke
50
License, Prohibit From Industry, Impose Fine, Order Restitution and Collect Investigation Fees
(the Statement of Charges) against WMC Mortgage and its principal owners individually. (See
Statement of Charges, No. C-07-557-08-SC01, Jun. 4, 2008.) The Statement of Charges
included 86 loan files, which revealed that at least 76 loans were defective or otherwise in
violation of Washington State law. (Id.) Among other things, the investigation uncovered that
WMC had originated loans with unlicensed or unregistered mortgage brokers, understated
amounts of finance charges on loans, understated amounts of payments made to escrow
companies, understated annual percentage rates to borrowers and committed many other
violations of Washington State deceptive and unfair practices laws. (Id.)
iii. IndyMac Violated Its Underwriting Guidelines
118. IndyMac, which originated the loans for one of the Securitizations, was the
subject of a February 26, 2009 report issued by the Office of Inspector General (OIG) of the
U.S. Department of Treasury entitled Safety and Soundness: Material Loss Review of IndyMac
Bank, FSB (the OIG Report). The OIG Report found that IndyMac Bank had embarked on a
path of aggressive growth that was supported by its high-risk business strategy of originating
Alt-A loans on a large scale and then packag[ing] them together in securities and selling
them on the secondary market to investors. (OIG Report at 2, 6, 7.) The OIG Report further
stated that: To facilitate this level of [loan] production . . . IndyMac often did not perform
adequate underwriting. (Id. at 2 (emphasis added).)
119. A June 30, 2008 report by the Center for Responsible Lending found that
IndyMac Bank often ignored its stated underwriting and appraisal standards and encouraged its
employees to approve loans regardless of a borrowers ability to repay them. (See IndyMac:
What Went Wrong? How an Alt-A Leader Fueled its Growth with Unsound and Abusive
Mortgage Lending (the CRL Report).) The CRL Report noted that IndyMac Bank engaged in
51
unsound and abusive lending practices and allowed outside mortgage brokers and in-house
sales staffers to inflate applicants [financial information] . . . [to] make them look like better
credit risks. (See CRL Report at 2, 8.)
iv. Wilmington Violated Its Underwriting Guidelines
120. Wilmington was an originator for three of the Securitizations purchased by the
GSEs. As disclosed in the Prospectus Supplement to the MSHEL 2005-4 Securitization,
Wilmington originated $2.2 billion in mortgage loans in 2003, $10.3 billion in mortgage loans in
2004 and $7.2 billion in mortgage loans during the period commencing on January 1, 2005 and
ending on June 30, 2005.
121. Wilmington and other affiliated companies, including its parent company AIG
Federal Savings Bank (AIG FSB), were the subject of a government investigation into their
lending practices. The Office of Thrift Supervision, based on the exercise of its regulatory
responsibilities, determined that AIG FSB failed to manage and control the mortgage lending
activities outsourced to [Wilmington] in a safe and sound manner . . . . (Supervisory Agreement
at 1.) The stated purpose of the Supervisory Agreement was, among other things, to correct and
remediate the negative financial impact to certain borrowers from the insufficiently supervised
lending activities of [AIG FSB] outsourced to [Wilmington]. . . . (Id. at 2.) Thus, pursuant to
that agreement, Wilmington and its affiliates established a $128 million reserve to cover, among
other things, costs associated with providing affordable loans to borrowers whose
creditworthiness was not adequately evaluated at the time the loan was originated. (Id.)
Moreover, AIG FSB agreed to improving its mortgage loan origination polices to enhance its
compliance will applicable laws and regulations. (Id.)
52
b. The Collapse of the Certificates Credit Ratings Further Shows
that the Mortgage Loans were not Originated in Adherence to
the Stated Underwriting Guidelines
122. The total collapse in the credit ratings of the Certificates invested in by the GSEs,
typically from AAA or its equivalent to non-investment speculative grade, is further evidence of
the originators systematic disregard of underwriting guidelines, underscoring that these
Certificates were impaired from the start.
123. The Certificates purchased by the GSEs originally were assigned credit ratings of
AAA or its equivalent, which purportedly reflected the description of the mortgage loan
collateral and underwriting practices set forth in the Registration Statements. Those ratings
artificially were inflated, however, upon information and belief in part as a result of the same
misrepresentations that the Defendants made to investors in the Prospectus Supplements.
124. Upon information and belief, Morgan Stanley provided information to the rating
agencies, including LTV ratios, owner-occupancy rates and other loan statistics, that the agencies
used in part to calculate the assigned ratings of the Certificates purchased by the GSEs. Upon
information and belief, because the information that Morgan Stanley provided, which
information included, among other things, the Registration Statements or portions thereof, the
ratings were inflated. As a result, the Certificates were offered and purchased at prices suitable
for investment grade securities, when in fact the Certificates carried a severe risk of loss and
inadequate credit enhancement.
125. Since the issuance of the Certificates purchased by the GSEs, the ratings agencies
have downgraded their ratings dramatically to reflect the revelations regarding the true
53
underwriting practices used to originate the mortgage loans, and the true value and credit quality
of the mortgage loans. Table 8 details the extent of the downgrades.
13
Table 8
Transaction Tranche
Rating at Issuance
(Moodys/S&P/Fitch)
Rating as of July 31, 2011
(Moodys/S&P/Fitch)
AMIT 2005-4 1A1 Aaa/AAA/ -- Aaa/AAA/--
MSAC 2005-HE5 A1 Aaa/AAA/AAA Aa1/AAA/AAA
MSAC 2005-HE6 A1 Aaa/AAA/AAA A1/AAA/A
MSAC 2006-HE3 A1 Aaa/AAA/AAA Caa2/CCC/CC
MSAC 2006-HE5 A1 Aaa/AAA/AAA Ca/B-/C
MSAC 2006-HE6 A1 Aaa/AAA/AAA Ca/CCC/C
MSAC 2006-HE8 A1 Aaa/AAA/-- Ca/CCC/--
MSC 2006-NC2 A1
Aaa/AAA/AAA Caa3/B-/CC
MSAC 2006-NC3 A1 Aaa/AAA/AAA Caa1/B+/CC
MSAC 2006-NC4 A1 Aaa/AAA/AAA Caa3/CCC/CC
MSAC 2006-WMC2 A1 Aaa/AAA/AAA Ca/CCC/C
MSAC 2007-HE1 A1 Aaa/AAA/-- Ca/CCC/--
MSAC 2007-HE5 A1 Aaa/AAA/-- Ca/CCC/--
MSAC 2007-HE7 A1 Aaa/AAA/-- Caa3/CCC/--
MSAC 2007-NC1 A1 Aaa/AAA/-- Ca/CCC/--
MSC 2006-HE2 A1 Aaa/AAA/AAA Caa2/CCC/CC
MSHEL 2005-4 A1 Aaa/AAA/AAA A2/AAA/A
MSM 2005-10 3A Aaa/AAA/-- Caa2/CC/--
MSM 2005-7 5A Aaa/AAA/-- Caa2/CC/--
MSM 2006-16AX 1A Aaa/AAA/-- Ca/CCC/--
MSM 2006-2 7A1 Aaa/AAA/-- Caa2/CC/--
MSM 2006-2 7A2 Aaa/AAA/-- C/CC/--
MSM 2007-2AX 1A Aaa/AAA/-- Ca/CCC/--
MSM 2007-5AX 1A Aaa/AAA/-- Ca/CCC/--
MSM 2007-7AX 1A Aaa/AAA/-- Ca/CCC/--
NCHET 2005-B A1 Aaa/AAA/-- Ba1/AA/--
NCHET 2005-C A1 Aaa/AAA/-- B3/CCC/--
NCHET 2005-D A1 Aaa/AAA/-- Caa2/B-/--
SAST 2005-3 A1A Aaa/AAA/AAA Aaa/AAA/AA
SAST 2006-1 A1 Aaa/AAA/-- Aa2/A-/--
SAST 2006-2 A2 Aaa/AAA/AAA Ba3/BB+/CCC
13
Applicable ratings are shown in sequential order separated by forward slashes:
S&P/Moodys/Fitch. A double-hyphen indicates that the relevant agency did not provide a
rating at issuance.
54
Transaction Tranche
Rating at Issuance
(Moodys/S&P/Fitch)
Rating as of July 31, 2011
(Moodys/S&P/Fitch)
SAST 2006-2 A1 Aaa/AAA/AAA Ba3/BB/CCC
SAST 2007-1 A1 Aaa/AAA/-- Caa3/CCC/--
SAST 2007-2 A1 Aaa/AAA/-- Caa2/CCC/--
SAST 2007-3 1A Aaa/AAA/AAA Caa2/CCC/CC
SAST 2007-3 1M1 Aa1/AA+/AA+ C/CCC/C
SAST 2007-3 1M2 Aa2/AA/AA+ C/CCC/C
SAST 2007-3 1M3 Aa3/AA-/AA C/CCC/C
SAST 2007-3 1M4 A1/A+/AA- C/CCC/C
SAST 2007-3 1M5 A2/2/A+ C/CCC/C
SAST 2007-3 1M6 A3/A-/A C/CC/C
c. The Surge in Mortgage Delinquency and Default Further
Demonstrates that the Mortgage Loans Were Not Originated
in Adherence to the Stated Underwriting Guidelines
126. Even though the Certificates were marketed as long-term, stable investments, a
significant percentage of the mortgage loans backing the Certificates have defaulted, have been
foreclosed upon, or are delinquent, resulting in massive losses to the Certificateholders. The
overall poor performance of the mortgage loans is a direct consequence of the fact that their
underlying mortgage loans were not underwritten in accordance with applicable underwriting
guidelines as represented in the Prospectus Supplements.
127. Loan groups that were underwritten properly and contained loans with the
characteristics represented in the Prospectus Supplements would have experienced substantially
fewer payment problems and substantially lower percentages of defaults, foreclosures, and
delinquencies than occurred here. Table 9 reflects the percentage of loans in the Supporting
Loan Groups that are in default, have been foreclosed upon, or are delinquent as of July 2011.
Table 9
Transaction
Supporting Loan
Group
Percentage of
Delinquent/Defaulted/Foreclosed
Loans
AMIT 2005-4 Group I 42.6%
MSAC 2005-HE5 Group I 53.4%
55
Transaction
Supporting Loan
Group
Percentage of
Delinquent/Defaulted/Foreclosed
Loans
MSAC 2005-HE6 Group I 45.6%
MSAC 2006-HE3 Group I 42.8%
MSAC 2006-HE5 Group I 62.9%
MSAC 2006-HE6 Group I 70.0%
MSAC 2006-HE8 Group I 42.0%
MSC 2006-NC2 Group I 39.9%
MSAC 2006-NC3 Group I 33.3%
MSAC 2006-NC4 Group I 45.4%
MSAC 2006-WMC2 Group I 49.8%
MSAC 2007-HE1 Group I 53.8%
MSAC 2007-HE5 Group I 56.4%
MSAC 2007-HE7 Group I 50.0%
MSAC 2007-NC1 Group I 54.0%
MSC 2006-HE2 Group I 44.3%
MSHEL 2005-4 Group I 33.7%
MSM 2005-10 Group 3 19.7%
MSM 2005-7 Group 5 11.8%
MSM 2006-16AX Group 1 47.1%
MSM 2006-2 (7A1) Group 7 16.1%
MSM 2006-2 (7A2) Group 7 16.1%
MSM 2007-2AX Group 1 33.9%
MSM 2007-5AX Group 1 49.7%
MSM 2007-7AX Group 1 44.2%
NCHET 2005-B Group I 37.3%
NCHET 2005-C Group I 47.1%
NCHET 2005-D Group I 50.6%
SAST 2005-3 Group 1 35.5%
SAST 2006-1 Group 1 39.8%
SAST 2006-2 Group 2 39.3%
SAST 2006-2 Group 1 39.8%
SAST 2007-1 Group 1 41.2%
SAST 2007-2 Group 1 31.0%
SAST 2007-3 (A1, 1M1-1M6) Group 1 39.8%
128. The confirmed misstatements concerning owner-occupancy and LTV ratios; the
confirmed systematic underwriting failures by the originators responsible for the mortgage loans
across the Securitizations; and the extraordinary drop in credit rating and rise in delinquencies
across those Securitizations all indicate that the mortgage loans in the Supporting Loan Groups,
56
contrary to the representations in the Registration Statements, were not originated in accordance
with the stated underwriting guidelines.
E. FANNIE MAES AND FREDDIE MACS
PURCHASES OF THE CERTIFICATES
129. Between September 12, 2005 and September 28, 2007, Freddie Mac and Fannie
Mae purchased over $10.58 billion in RMBS issued in connection with the Securitizations.
Tables 10 and 11 reflect each of Freddie Macs and Fannie Maes purchases of the Certificates,
respectively.
14
To date, the GSEs have not sold any of the Certificates.
Table 10
Transaction Tranche CUSIP
Settlement
Date of
Purchase by
Freddie Mac
Initial Unpaid
Principal
Balance
Purchase
Price (% of
Par)
Seller to
Freddie Mac
AMIT 2005-4 1A1 00252FDF5 09/12/05 446,899,000.00 100 MS&Co.
MSAC 2005-HE5 A1 61744CUN4 10/28/05 441,470,000.00 100 MS&Co.
MSAC 2005-HE6 A1 61744CVT0 11/29/05 337,122,000.00 100 MS&Co.
MSAC 2006-HE6 A1 61750FAA8 09/27/06 324,649,000.00 100 MS&Co.
MSC 2006-NC2 A1 617451EB1 03/30/06 886,897.00 100 MS&Co.
MSAC 2006-NC3 A1 61744CYZ3 04/28/06 426,670,000.00 100 MS&Co.
MSAC 2006-NC4 A1 61748LAA0 06/23/06 536,150,000.00 100 MS&Co.
MSAC 2006-WMC2 A1 61749KAA1 06/28/06 581,960,000.00 100 MS&Co.
MSAC 2007-HE1 A1 617526AA6 01/26/07 309,100,000.00 100 MS&Co.
MSAC 2007-NC1 A1 617505AA0 01/26/07 320,559,000.00 100 MS&Co.
MSHEL 2005-4 A1 61744CVE3 11/29/05 335,337,000.00 100 MS&Co.
MSM 2005-10 3A 61748HSG7 11/30/05 40,296,000.00 99.7421875 MS&Co.
MSM 2005-7 5A 61748HPE5 10/31/05 26,951,000.00 99.640625 MS&Co.
MSM 2006-16AX 1A 617487AA1 10/31/06 182,501,000.00 100 MS&Co.
MSM 2006-2 7A1 61748HVY4 02/28/06 31,903,000.00 100.265625 MS&Co.
MSM 2006-2 7A2 61748HVZ1 02/28/06 3,545,000.00 100.265625 MS&Co.
MSM 2007-2AX 1A 61751TAA7 01/31/07 157,974,000.00 100 MS&Co.
MSM 2007-7AX 1A 61754HAA0 04/30/07 177,425,000.00 100 MS&Co.
NCHET 2005-B A1 64352VNE7 09/29/05 590,249,000.00 100 MS&Co.
NCHET 2005-C A1 64352VNU1 12/06/05 549,534,000.00 100 MS&Co.
NCHET 2005-D A1 64352VPK1 12/28/05 411,566,000.00 100 MS&Co.
SAST 2005-3 A1A 805564SM4 09/29/05 360,900,000.00 100 RBS
SAST 2006-1 A1 80556UAA1 05/02/06 199,612,000.00 100 Credit Suisse
SAST 2006-2 A2 80556XAB3 06/07/06 197,374,000.00 100 Credit Suisse
SAST 2007-1 A1 80556BAA3 03/07/07 209,071,000.00 100 MS&Co.
14
Purchases and holdings of securities in Table 10 are stated in terms of UPB of the
relevant Certificates. Purchase prices are stated in terms of percentage of par.
57
Table 11
Transaction Tranche CUSIP
Settlement
Date of
Purchase by
Fannie Mae
Initial Unpaid
Principal
Balance
Purchase
Price (% of
Par)
Seller to
Fannie Mae
MSAC 2006-HE3 A1 61749HAA8 05/25/06 381,635,000.00 100 MS&Co.
MSAC 2006-HE5 A1 61749NAA5 06/30/06 319,485,000.00 100 MS&Co.
MSAC 2006-HE8 A1 61750SAA0 11/29/06 226,710,000.00 100 MS&Co.
MSAC 2007-HE5 A1 61753KAA4 04/26/07 119,919,000.00 100 MS&Co.
MSAC 2007-HE7 A1 61756YAA1 09/28/07 670,205,000.00 100 MS&Co.
MSC 2006-HE2 A1 617451ER6 04/28/06 435,720,000.00 100 MS&Co.
MSM 2007-5AX 1A 61751GAA5 02/28/07 127,608,000.00 100 MS&Co.
SAST 2006-2 A1 80556XAB3 06/07/06 197,374,000.00 100 Credit Suisse
SAST 2007-2 A1 80556YAA3 04/30/07 192,705,000.00 100 MS&Co.
SAST 2007-3 1A 80557BAA2 08/03/07 569,917,000.00 100 MS&Co.
SAST 2007-3 1M1 80557BAF1 08/03/07 36,690,000.00 100 MS&Co.
SAST 2007-3 1M2 80557BAH7 08/03/07 33,021,000.00 100 MS&Co.
SAST 2007-3 1M3 80557BAK0 08/03/07 21,198,000.00 100 MS&Co.
SAST 2007-3 1M4 80557BAM6 08/03/07 17,937,000.00 100 MS&Co.
SAST 2007-3 1M5 80557BAP9 08/03/07 17,937,000.00 100 MS&Co.
SAST 2007-3 1M6 80557BAR5 08/03/07 16,307,000.00 98.9544 MS&Co.
F. FANNIE MAE AND FREDDIE MAC WERE
DAMAGED BY DEFENDANTS VIOLATIONS
OF SECTIONS 11, 12, AND 15 OF THE SECURITIES ACT
130. The statements and information in the Registration Statements regarding the
credit quality and characteristics of the mortgage loans underlying the GSE-purchased
Certificates, and the origination and underwriting practices pursuant to which the mortgage loans
purportedly were originated, were material to a reasonable investor. But for the
misrepresentations and omissions in the Registration Statements concerning those matters,
Fannie Mae and Freddie Mac would not have purchased the Certificates.
131. Based upon sales of the Certificates or similar certificates in the secondary
market, or other indications of value, the GSEs have incurred substantial losses on the
Certificates due to a decline in value that is directly attributable to Defendants material
misrepresentations and omissions. Among other things, the mortgage loans underlying the
Certificates experienced defaults and delinquencies at a higher rate than would have been the
58
case had the loans underlying the Certificates actually conformed to the origination guidelines,
and had the Certificates merited the credit ratings set forth in the Registration Statement.
132. Defendants misstatements and omissions in the Registration Statement were the
direct, proximate and actual cause of the GSEs losses resulting from their purchase of the
Certificates. Although clearly significant, the precise extent of Freddie Macs injuries will be
proven at trial.
133. At the time of their purchases of the Certificates, Fannie Mae and Freddie Mac
were unaware of Defendants misrepresentations, omissions and/or untrue statements. Plaintiff
was appointed Conservator of Fannie Mae and Freddie Mac less than one year after the
discovery of the untrue statements and omissions contained in the Registration Statements and
within three years of the Certificates being offered for sale to the public. Despite the exercise of
reasonable diligence, Fannie Mae and Freddie Mac could not reasonably have discovered the
untrue statements and omissions in the Registration Statements more than one year prior to the
appointment of the Plaintiff as Conservator. This action is timely pursuant to 12 U.S.C.
4617(b)(12) and (13), which provides for extension and tolling of all time periods applicable
to the claims brought herein. Moreover, the time period since June 5, 2009 has been tolled for
statute of limitations purposes by virtue of a tolling agreement entered into between Fannie Mae
and Defendants MS&Co., MSAC, MSMC, SFM and SCI.
II. ADDITIONAL FACTUAL ALLEGATIONS
134. The allegations in paragraphs 135 through 138 below addressing Defendants
knowledge or recklessness concerning the information set forth in or omitted from the
Registration Statements and any other materials provided to Freddie Mac are made solely with
respect to Plaintiffs common law claims.
59
A. Defendants Were Incentivized to Fund
Risky Residential Mortgage Loans and
To Securitize and Sell Them to Investors
135. Securitizing large volumes of loans was a highly lucrative and competitive
business for the Defendants. All of the underwriter defendants engaged in this business on a
massive scale, each doing multiple billions of dollars worth of securitizations during the period
when they sold the Certificates to the GSEs. Fees, which were a percentage of the balance of the
loan pool being purchased, and other transaction revenues associated with the Certificates at
issue here, and the RMBS securitization business generally, accounted for a substantial portion
of the underwriter (and other) Defendants earnings in the relevant time period. The more and
the larger the securitizations the Defendants arranged and participated in, the greater their
earnings. This financial motive accounts for Defendants willingness, intentionally or recklessly,
to make false statements in, or to omit material facts from, the Registration Statements and other
offering materials. In furtherance of this motive, the Defendant underwriters took measures and
entered into arrangements designed to ensure that a continuous and high volume of mortgage
loans would be available for securitization.
136. Thus, among other things, the Defendant banks provided warehouse funding to
mortgage originators to enable these originators to make, and to continue to make, loans. These
subprime mortgage originators used those funds to make large numbers of loans, which they then
turned around and sold back to the banks whose funds enabled them to make the loans in the first
place. The banks then securitized the loans they effectively funded, and transferred the risk to
investors like Fannie Mae and Freddie Mac through the sale of the RMBS resulting from the
securitizations.
137. These arrangements between the banks and loan originators undermined the
underwriting process for the Certificates because the Defendant underwriters had no incentive to
60
identify and exclude from the securitizations loans that did not conform to the loan originators
stated guidelines. To the contrary, the Defendants had the motive to, and did, include loans that
they knew -- or were reckless in not knowing -- did not conform to those guidelines, and that
lacked the characteristics or merited the ratings set forth in the Registration Statement.
138. The originator responsible for the largest of loans underlying the Certificates was
New Century, now known to be one of the worst subprime lenders.
139. MS&Co., Credit Suisse, Citigroup, Bear Stearns, Merrill Lynch, Bank of
America, and Deutsche Bank -- all of whom were underwriters of the Securitizations -- provided
billions of dollars of warehouse lending to New Century. In 2006, MS&Co. provided $3 billion
and $650 million in warehouse loans to New Century and American Home, respectively.
(Assurance of Discontinuance 12.)
140. In addition to MS&Co., the other underwriters of the Securitizations engaged in
warehouse lending as well. From 2000 to 2010, Citi extended warehouse lines of credit of up to
$7 billion to unaffiliated originators, including $950 million to New Century and over $3.5
billion to Ameriquest. (FCIC Report at 113.) Citi and JPM lent their own mortgage origination
subsidiaries at least $26.3 billion and $30 billion, respectively, between 2005 and 2007. (See
Who is Behind The Financial Meltdown: The Top 25 Subprime Lenders and their Wall Street
Backers, The Center for Integrity, available at
http://www.publicintegrity.org/investigations/economic_meltdown/the_subprime_25/.) Upon
information and belief, RBS also engaged in the same warehouse lending practices.
141. The lending relationship between the investment banks and the originators did not
merely assure that there would be a high volume of loans generally available to securitize. It
also gave the banks the inside track on acquiring for securitization the loans generated with their
61
funds. Thus, for example, according to the Assurance of Discontinuance filed by the
Massachusetts Attorney General, Morgan Stanley sometimes would commit to buying loans
from New Century months in advance, such that New Century was often originating loans for the
purpose of fulfilling its commitment to Morgan Stanley. (Assurance of Discontinuance 12).
Morgan Stanleys warehouse loan was then repaid when the originators loan pool was sold to
Morgan Stanley for securitization.
142. To make matters worse, upon information and belief, because Morgan Stanley
had agreed in advance to buy the loans securing its warehouse lines, it was committed to
purchasing the loans regardless of their credit quality or despite the results of its own due
diligence. If Morgan Stanley were to reject too many loans, it would jeopardize its relationship
with lenders, such as New Century, and also decrease its own profits because of the resulting
reduction in the size of the securitizations. Thus, for example, in one instance, after New
Century complained to Morgan Stanley about the rate of loan rejection and suggested that New
Century would shift its business to other buyers, Morgan Stanley purchased the loans that its
internal due diligence team initially had rejected. (Assurance of Discontinuance 24-25.)
143. In a March 21, 2007 earnings conference call, Morgan Stanley highlighted its
integrated approach to RMBS, without disclosing the inherent conflicts of interest:
We participate in the subprime mortgage market in a number of ways. Through
our securitized product groups we purchased loans from originators and originate
loans, including through Saxon, which closed this quarter. We are active in the
structuring, securitization, and distribution of subprime products, including CLOs
and CDOs. Third, we manage our risk through a variety of hedging strategies and
we also take proprietary risk positions. In the aggregate, these activities were a
significant contributor to our results this quarter. In addition, we extend loans and
lending commitments to clients that are secured by assets of the borrower such as
loan pools. At the end of the quarter, whereas [sic] lending commitments to the
subprime lenders totaled $5.2 billion, of which $2.3 billion was funded and fully
collateralized. The largest component of this was the New Century. Our current
62
funded balance with New Century is $2.5 billion. Finally, through our acquisition
of Saxon, we have servicing capabilities.
(Morgan Stanley F1Q07 (Qtr End 2/28/07) Earnings Call Transcript, March 21, 2007,
http://seekingalpha.com/article/30299-morgan-stanley-f1q07-qtr-end-2-28-07-earnings-call-
transcript (last visited Aug. 19, 2011).)
144. Morgan Stanley and other underwriters of the Securitizations were therefore
motivated to churn out and securitize as many mortgages as possible because they earned so
much in revenues on both ends of the securitization process, without bearing the ultimate risk of
default. Indeed, MS&Co. and each of the other underwriters ranked in the top ten of the nations
largest underwriters of RMBS between 2004 and 2007, according to Inside Mortgage Finance.
The three underwriters that sold the Certificates to Fannie Mae and Freddie Mac -- Morgan
Stanley, Credit Suisse, and RBS -- were especially prolific.
145. From 2005 through 2007, when the Certificates were issued and subsequently
purchased by Fannie Mae and Freddie Mac, Morgan Stanley greatly increased the volume of
RMBS it issued by, among other things, acquiring Defendant SCI and its subsidiaries SMI, SFM,
and SASC, which acted as originator, sponsor, and depositor for RMBS, respectively. Thus,
whereas the approximate initial principal amount of securities backed by mortgage loans that
Morgan Stanley initially issued was relatively small -- roughly $0.4 billion in 2000 -- by 2006,
the amount had ballooned to $26 billion. By 2007, Morgan Stanley ranked tenth with $26.8
billion in transactions, RBS was fifth with $50.3 billion, and Credit Suisse ranked sixth with
$44.1 billion. (2011 Mortgage Market Statistical Annual, Vol. II (Inside Mortgage Finance
Publns, Inc., 2011).)
63
B. Defendants Material Misrepresentations
and Omissions in the Offering Materials
146. In connection with the sale of the Certificates, the selling underwriters MS&Co.,
Credit Suisse and RBS; the depositors MSAC, MSC and SASC; and the sponsors MSMC and
SFM (together, the Fraud Defendants) each made misrepresentations and omissions of material
fact to Fannie Mae and Freddie Mac in term sheets, Registration Statements, Prospectuses,
Prospectus Supplements, and other draft and final written offering documents (the Offering
Materials) These Offering Materials described the credit quality and other characteristics of the
underlying mortgage loans on an aggregate basis and were provided to investors, including the
GSEs.
147. Accordingly, Fannie Mae and Freddie Mac required the Fraud Defendants to
provide representations and warranties regarding the origination and quality of the mortgage
loans, including that the mortgage loans had been underwritten by the loan originators pursuant
to extensive guidelines.
148. Through term sheets or other offering documents, the Fraud Defendants also
furnished the GSEs with anticipated credit ratings on the proposed pool of mortgage loans
intended for securitization.
149. On information and belief, the Fraud Defendants solicited anticipated ratings from
credit rating agencies based on misrepresentations by Defendants as to the credit quality of the
proposed pool of mortgage loans intended for securitization, and the amount of the
overcollateralization in the deal. Virtually all the Securitizations had anticipated ratings of at
least AAA or its equivalent.
64
150. Furthermore, the Fraud Defendants delivered Prospectus Supplements to the
GSEs that included more specific information about the loans underlying the Certificates in each
Securitization.
151. The materially false and misleading information contained in the initial and final
Prospectus Supplements that the Fraud Defendants provided to the GSEs included reproductions
of the same schedules that the Fraud Defendants provided to the GSEs, containing false data
about LTV ratios and owner-occupancy statistics.
152. The Offering Materials, among other things, (1) misrepresented the loans and loan
originators adherence to the stated underwriting guidelines; (2) overstated the number of loans
for owner-occupied properties; (3) understated the loan pools average LTV ratios; and (4) failed
to disclose that the credit ratings of the Certificates were based on false information. Each
misrepresentation and omission created an additional, hidden layer of risk well beyond that
known to be associated with non-agency loans or subprime loans.
153. First, the Fraud Defendants statements regarding the mortgage pools compliance
with stated underwriting guidelines were false. The falsity of such representations is evident
from disclosures concerning the originators systematic disregard of their stated underwriting
guidelines, as well as the Certificates high default rates and plummeting credit ratings. Indeed,
of the 18 originators whose loans were sold into the Securitizations, six were cited as one of the
worst ten in the worst ten metropolitan areas: American Home, Decision One, Greenpoint,
IndyMac, New Century, and WMC. Government and private investigations have confirmed that
these originators failed to apply any standards at all when making high-risk loans. Moreover, the
subsequent high default rates and ultimately lowered credit ratings on the Certificates confirm
that the loans were not properly underwritten in the first place. As shown in Tables 8 and 9, the
65
average rate of default across the Securitizations is 41.7 percent, and although 35 of the tranches
of Certificates purchased by the GSEs had been rated AAA (or its equivalent) at the time of
purchase, by July 31, 2011, all but two had been had been downgraded, and most had been
downgraded to junk or nearly junk-bond status, with 25 downgraded to CCC (or its equivalent),
the lowest rating above junk. See supra Part (I)(D)(2).
154. These misstatements were material because as discussed above, the quality of
loans in the pool determined the risk of the Certificates backed by those loans. Because a
reasonable underwriting process had not been followed, the entire loan pool was much riskier
and more prone to default and market losses than represented. The systemic underwriting
failures decreased the reliability of all the information provided to the GSEs about the loans, and
thus increased the actual risk to investors. As a result of those failures, the value of the
Certificates was substantially lower than the price paid by Fannie Mae and Freddie Mac for those
Certificates.
155. Second, as shown in Table 6, the Fraud Defendants materially understated the
non-owner-occupied status for each Securitization by an average of 10.1 percent.
156. Third, the Fraud Defendants understated the loan pools average LTV ratios,
which overstated the borrowers equity cushion in the property. As Table 7 demonstrates, on
average, only 42.4 percent of the loans actually had LTV ratios of less than 80 percent, as
opposed to 65.7 percent as represented in the Prospectus Supplements. Moreover, while all of
the Certificates purchased by the GSEs were represented to have no loans with an LTV over 100
percent, in reality, all but five deals contained at least 10.5 percent loans with greater than 100
percent LTV, with an average of 15.55 percent. In other words, in almost all of the
Securitizations, a significant percentage of the mortgage loans either were under-secured or
66
under water from the start. The understatement of LTV ratios was misleading because it
misrepresented the risk of a borrower abandoning a property if the value dropped below the
unpaid balance of the loan, as well as the risk that proceeds from a foreclosure sale would fail to
cover the unpaid balance.
157. Further, the Fraud Defendants failed to disclose that the Certificates credit ratings
were false and misleading because Defendants provided to the ratings agencies the same
misinformation found in the Offering Materials in an attempt to manufacture predetermined
ratings. In testimony before the Senate Permanent Subcommittee on Investigations (SPSI),
Susan Barnes, the North American Practice Leader for RMBS at S&P from 2005 to 2008,
confirmed that the rating agencies relied upon investment banks to provide accurate information
about the loan pools:
The securitization process relies on the quality of the data generated about the loans
going into the securitizations. S&P relies on the data produced by others and reported
to both S&P and investors about those loans . . . . S&P does not receive the original
loan files for the loans in the pool. Those files are reviewed by the arranger or sponsor
of the transaction, who is also responsible for reporting accurate information about the
loans in the deal documents and offering documents to potential investors.
(SPSI hearing testimony, April 23, 2010) (emphasis added). As a result, the ratings failed to
reflect accurately the actual risk underlying the Certificates purchased by the GSEs because the
ratings agencies were analyzing a mortgage pool that had no relation to the pool that actually
backed the Certificates purchased by the GSEs.
158. Senior executives at Moodys also confirmed that they were fed and relied on
false information that affected their ratings:
Were on notice that a lot of the things that we relied on before just werent
true.
Theres a lot of fraud thats involve there, things we dont see. . . . Were sort of
retooling [our methodologies and approaches] to make sure that we capture a lot
67
of things that we relied on in the past that we cant rely on, on a going forward
basis.
Its actually quite interesting that were being asked to figure out how much
everybody lied. . . . I mean, if all of the information was truthful and
comprehensive and complete, we wouldnt have an issue here.
159. The AAA (or equivalent) anticipated and final credit ratings were material to
Fannie Mae and Freddie Mac, because the ratings provided additional assurances that the GSEs
would receive the expected interest and principal payments. Fannie Mae and Freddie Mac would
not have purchased the Certificates without the proper ratings and would not have paid as much
for them without the investment grade status.
160. Each of the Fraud Defendants is responsible for the representations made in or
omitted from the Offering Materials. Specific false and misleading statements in the
Registration Statements for the Certificates purchased by the GSEs are detailed in Parts (I)(C)
and (I)(D), supra and Appendix A, which is incorporated by reference.
161. Because payment on the Certificates ultimately was funded by payments from the
mortgagors, Fannie Mae and Freddie Mac faced a risk of non-payment if too many borrowers
defaulted on their loans and the value of the mortgaged properties was insufficient to cover the
unpaid principal balance. By misrepresenting the true risk profile of the underlying loan pools,
the Fraud Defendants defrauded Fannie Mae and Freddie Mac.
162. As the FCIC found:
The Commission concludes that firms securitizing mortgages failed to perform
adequate due diligence on the mortgages they purchased and at times
knowingly waived compliance with underwriting standards. Potential investors
were not fully informed or were misled about the poor quality of the mortgages
contained in some mortgage-related securities. These problems appear to have
been significant.
(FCIC Report at 187 (emphasis added).)
68
C. The Fraud Defendants Knew or Were
Reckless in Not Knowing That Their
Representations Were False and Misleading
163. The Fraud Defendants knew or were reckless in not knowing that their
representations in the Offering Materials were false, and that the information they omitted from
those documents rendered them materially misleading. The consistency of the
misrepresentations and omissions across all of the 33 Securitizations is strong evidence that the
Fraud Defendants did not innocently make materially false statements and omissions, but
actually knew or were reckless in not knowing that (1) the loan originators systemically
disregarded their own underwriting guidelines, (2) the LTV ratios presented in the Offering
Materials were materially inaccurate, (3) the owner-occupancy rates presented in the Offering
Materials were materially inaccurate, and (4) the credit ratings for the Certificates were based on
incomplete and inaccurate information and were not believed by the ratings agencies when
provided. In the case of the Morgan Stanley Defendants -- which structured, implemented, or
underwrote all of the Securitizations -- the securities underwriting due diligence process was so
compromised that Morgan Stanley cannot have believed in the truth of, or had a sound basis for
believing, the representations in the Offering Materials, and had to have known that the
information omitted therefrom was material and rendered the information provided misleading.
Thus, for example, the FCIC, in its report on the financial crisis, expressly found that Morgan
Stanleys due diligence apparatus was inadequate both in its size and geographic location,
stating:
At Morgan Stanley, the head of due diligence was based not in New York
but rather in Boca Raton, Florida. He had, at any one time, two to five
individuals reporting to him directly -- but they were actually employees
of a personnel consultant. . .
(FCIC Report at 168) (footnote omitted).)
69
164. Thus, Morgan Stanley had two to five people in Boca Raton, Florida performing
due diligence on tens of billions of dollars worth of securitizations being originated and run from
New York. This alone renders it more likely than not that Morgan Stanley lacked capacity and
controls to determine that the representations in the Registration Statements concerning the
securitizations were true. As described below, Morgan Stanley hired a third-party due-diligence
firm to supplement their inadequately staffed due-diligence team, then ignored that firms
warnings about loans that became part of RMBS, including the Certificates.
165. Morgan Stanleys lax due diligence standards, and its failure to present accurate
and complete information concerning the loan origination practices of the originators whose
loans underlie the Certificates, were likely attributable at least in part to the warehouse lending
relationships it had with several of those originators, and to the fact that Morgan Stanley was
dependent on those originators to feed it the high volume of loans it needed to keep churning out
securitizations. The FCIC found that underwriter/originator warehouse lending relationships led
to an environment in which financial institutions ineffectively sampled loans they were
purchasing to package and sell to investors, and knew a significant percentage of the sampled
loans did not meet their own underwriting standards or those of the originators. Nonetheless,
they sold those securities to investors. The Commissions review of many prospectuses provided
to investors found that this critical information was not disclosed. (FCIC Report at xii.)
166. Given Morgan Stanleys close relationships with the originators for the
Certificates at issue here, it had a unique window into the true credit quality of the loans backing
the Certificates and undue influence over the loan origination process. As one industry
publication explained, warehouse loan providers had detailed knowledge of the [mortgage]
70
lenders operations. (Kevin Connor, Wall Street and the Making of the Subprime Disaster,
November 2007 at 11.)
167. Morgan Stanleys warehouse lending and other relationships with New Century
were particularly close (and were the subject of the Massachusetts AG investigation and Morgan
Stanley settlement already alleged). New Centurys former president testified before the
Bankruptcy Examiner appointed by the Bankruptcy Court overseeing New Centurys Chapter 11
proceeding that New Century often reached deals with loan purchasers to limit the percentage of
loans the purchaser would kickout of the loan pool due to the poor quality of the loan. (See,
Final Report of Michael J. Missal Bankruptcy Court Examiner, Case No. 07-10416(KJC) (D.Del.
Feb. 29, 2008) at 135.) That admission, the warehouse lending relationship between New
Century and Morgan Stanley and the fact that Morgan Stanley did more business with this
worst of the worst originator than any other bank, strongly suggest that Morgan Stanley and
New Century had such a deal.
168. Morgan Stanley was not the only Defendant with a particularly close relationship
with New Century. According to the FCIC, Morgan Stanley and Credit Suisse together
accounted for three-quarters of all deals securitized using New Century mortgage loans as early
as 2003. (FCIC Report, at 89.) New Centurys systematic departure from its stated loan
origination guidelines has come to light in recent years. That departure has been extensively
investigated and reported on by, among others, the Bankruptcy Examiner in the New Century
Chapter 11 proceeding, the Massachusetts AG and the FCIC, as well as in the financial press.
Upon information and belief Morgan Stanley, Credit Suisse and other Defendants knew the
falsity of the representations in the Registration Statements that New Century loans underlying
various of the Certificates were originated in accordance with its underwriting guidelines, or at a
71
minimum these Defendants knew that neither they nor New Century had any basis to represent
otherwise. These Defendants also intentionally or recklessly omitted the truth about New
Centurys origination practices.
169. Morgan Stanleys knowledge concerning New Centurys origination practices
went far beyond a general awareness that New Century was systematically disregarding its own
guidelines. During the 2005 to 2006 period, Morgan Stanley had determined, in reviewing and
rejecting loans for purchase, that the stated income on a number of New Century loans was
unreasonable and that stated income credit had not been adequately evaluated by New Century.
This raised red flags because approximately 36 percent of the loans originated by New Century
were stated income loans. A Morgan Stanley employee described the stated income method of
verifying borrower income as overused to the point of abuse. (Assurance of Discontinuance
38.) On average, the stated income of the borrowers for these New Century loans was
approximately 42 percent higher than the income of borrowers who did not merely state their
income but rather submitted full documentation reflecting it; this discrepancy strongly indicated
that the stated income borrowers were materially overstating their income. (Assurance of
Discontinuance 39.)
170. The other Fraud Defendants, Credit Suisse and RBS, joined the Morgan Stanley
Defendants in consciously disregarding and departing from sound securities underwriting
standards, and in failing to disclose that they had done so and the fact that doing so rendered
information provided in the Registration Statements false, misleading and unreliable. These
Defendants intent or recklessness is further evidenced by their conduct in relation to third-party
due diligence providers.
72
171. Among the third-party due diligence experts engaged by the Fraud Defendants
was Clayton Holdings, Inc. (Clayton).
15
Clayton was hired to identify, among other things,
whether the loans met the originators stated underwriting guidelines and, in some measure, to
enable clients to negotiate better prices on pools of loans. (FCIC Report at 166 (footnote
omitted).) Yet, upon information and belief, the Fraud Defendants routinely disregarded and
manipulated Claytons findings.
172. In January 2008, Clayton disclosed that it had entered into an agreement with the
New York Attorney General (NYAG) to provide documents and testimony regarding its due
diligence reports, including copies of the actual reports provided to its clients. According to The
New York Times, as reported on January 27, 2008, Clayton told the NYAG that starting in 2005,
it saw a significant deterioration of lending standards and a parallel jump in lending
expectations and some investment banks directed Clayton to halve the sample of loans it
evaluated in each portfolio. Upon information and belief, Morgan Stanley, Credit Suisse and
RBS were included in that group of investment banks. Thus, these Defendants made a
conscious decision not to avail themselves of comprehensive due diligence regarding the loans
they were securitizing, which alone renders their misrepresentations concerning those loans
knowing or reckless.
173. For the 18 month period ending on June 31, 2007, a significant percentage of the
loans sampled by Clayton at the direction of the selling underwriters failed to meet the various
15
Clayton was the leading provider of third-party due diligence during the relevant time
period. In 2006, Clayton analyzed over $418 billion in loans underlying mortgage-backed
securities, which represented 22.8% of the total outstanding U.S. non-agency mortgage-backed
securities for that year. (Clayton, Form 10-K.) During 2004, 2005, and 2006, Clayton worked
with each of the ten largest non-agency mortgage-backed securities underwriters, as ranked by
Inside MBS & ABS, which accounted for 73% to 78% of the total underwriting volume during
those years.
73
loan originators underwriting guidelines. This information was provided to Morgan Stanley,
RBS, and Credit Suisse, but they overruled Claytons findings and waived in substantial
percentages of those loans (approximately 56 percent for Morgan Stanley, 53 percent for RBS,
and 33 percent for Credit Suisse).
174. Upon information and belief, these Defendants waived in these loans, found by
Clayton to be non-compliant with the relevant originators origination guidelines, without taking
any adequate steps of their own to verify Claytons findings. These loans then found their way
into RMBS that were sold to investors like the GSEs. (See Clayton Trending Reports, available
at http://fcic.law.stanford.edu/hearings/testimony/the-impact-of-the-financial-crisis-
sacramento#documents; FCIC Report, 167.)
175. The revelations concerning the Defendants routine disregard of Claytons due
diligence findings and recommendations further supports an inference of intent or recklessness
on the part of these Defendants with respect to the misrepresentations in and omissions from the
Offering Materials concerning adherence to loan origination standards, LTV ratios, owner-
occupancy rates, and credit ratings (among others).
176. Morgan Stanley personnel have admitted to Congressional investigators that
Morgan Stanleys loan review process was defective. In an interview with the FCIC, Tony
Peterson, a Vice President in Morgan Stanleys due diligence group, stated that Morgan Stanley
routinely rejected Claytons findings with respect to sampled loans. Mr. Peterson further
admitted that Morgan Stanley traders who created Morgan Stanleys RMBS deals had
information concerning the inferior quality of the loans they were securitizing and that
significant aspects of the due diligence process, including which loans were to be sampled, were
dictated by Morgan Stanley traders in New York.
74
177. Like the NYAG, the Massachusetts Attorney General also undertook an
investigation into the financing, purchase, and securitization of allegedly unfair residential
mortgage loans during the period late 2005 through the first half of 2007 by Morgan Stanley.
Although Morgan Stanley did not admit the allegations in the Assurance of Discontinuance
filed by the Massachusetts AG in resolution of that investigation, Morgan Stanley settled the
charges against it in exchange for a payment of $102 million. The core of the Massachusetts
AGs findings was that New Century systematically disregarded its own underwriting standards,
that Morgan Stanley had a partner-like relationship with New Century by virtue of the
warehouse lending relationship alleged above and otherwise, that Morgan Stanley routinely
disregarded Claytons findings with respect to New Centurys loan practices and New Century-
originated loans, and that New Centurys origination practices violated Massachusettss law.
The Massachusetts AGs investigation and allegations, and Morgan Stanleys willingness to
settle the matter for a sum in excess of one hundred million dollars, further support the
allegations herein of knowledge or recklessness on the part of Morgan Stanley.
178. The Fraud Defendants also knew or recklessly disregarded that the owner-
occupancy statistics and LTV ratios reported in the Offering Materials were false and
misleading. Given their role as underwriters of the Certificates, the relationships they had with
loan originators and their expertise in underwriting and securitizing RMBS, the Fraud
Defendants had the practical ability to gain access to loan files and the ability and resources to
test the reported data points, such as owner-occupancy rates and LTV ratios. They intentionally
elected not to do so, rendering their representations concerning those data knowingly or
recklessly false.
75
179. Moreover, upon information and belief, underwriters, including certain of the
Fraud Defendants, influenced the appraisals used to determine LTV ratios. Government
investigations have uncovered widespread evidence of appraisers being pressured to overvalue
properties so more loans could be originated. For instance, several witnesses, ranging from the
President of the Appraisal Institute to appraisers and lenders on the ground, confirmed that
appraisers felt compelled to come in at value -- i.e., at least the amount needed for the loan to
be approved -- or face losing future business or their livelihoods. Given the systemic pressure
applied to appraisers, upon information and belief, the appraisers themselves, the originators, and
the underwriters did not believe that the appraised values of the properties -- and therefore LTV
ratios -- were true and accurate at the time they communicated the information to potential
investors, including the GSEs.
180. Further, the Fraud Defendants knew or were reckless in not knowing that the
credit ratings reported for the Certificates failed to reflect the actual risk of the Certificates, and
that the ratings agencies had no basis to believe in the accuracy of those ratings. Not only did
these Defendants provide the ratings agencies with false loan-level information, but they also
routinely engaged in ratings shopping -- i.e., pressuring the ratings agencies for favorable
ratings and playing the rating agencies off one another with the threat of withholding future
business if the sponsoring bank was not given favorable treatment. As detailed in the SPSI
Report:
At the same time Moodys and S&P were pressuring their RMBS and CDO analysis to
increase market share and revenues, the investment banks responsible for bringing RMBS
and CDO business to the firms were pressuring those same analysts to ease rating
standards. Former Moodys and S&P analysts and managers interviewed by the
Subcommittee described, for example, how investment bankers pressured them to get
their deals done quickly, increase the size of the tranches that received AAA ratings, and
reduce the credit enhancements protecting the AAA tranches from loss. They also
pressed the CRA analysts and managers to ignore a host of factors that could be seen as
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increasing credit risk. Sometimes described as ratings shopping, the analysts described
how some investment bankers threatened to take their business to another credit rating
agency if they did not get the favorable treatment they wanted. The evidence collected
by the Subcommittee indicates that the pressure exerted by investment banks frequently
impacted the ratings process, enabling the banks to obtain more favorable treatment than
they otherwise would have received.
(See Sen. Levin, Carl and Sen. Coburn, Tom, U.S. Senate Permanent Subcommittee on
Investigations, Wall Street and the Financial Crisis: Anatomy of a Financial Collapse
(Committee on Homeland Security and Governmental Affairs, April 13, 2011) (the SPSI
Report), at 278.)
181. As one S&P director put it in an August 8, 2006 email: [Our RMBS friends
have] become so beholden to their top issuers for revenue [that] they have all developed a kind
of Stockholm syndrome which they mistakenly tag as Customer Value creation. Ratings
analysts who complained about the pressure, or did not do as they were told, were quickly
replaced on deals or terminated.
182. Summarizing the intense pressure investment banks put on ratings analysts to
provide favorable ratings, a former Moodys VP and Senior Credit Officer testified before the
FCIC that [t]he willingness to decline to rate, or to just say no to proposed transactions, steadily
diminished over time. That unwillingness to say no grew in parallel with the companys share
price and the proportion of total firm revenues represented by structured finance transactions . . .
coincident with the steady drive toward commoditization of the instruments we were rating . . . .
The threat of losing business . . . even if not realized, absolutely tilted the balance away from
independent arbiter of risk towards a captive facilitator of risk transfer . . . . The message from
management was . . . Must say yes. (See Written Testimony of Richard Michalek (FCIC
Hearing, June 2, 2010), available at http://fcic-static.law.stanford.edu/cdn_media/fcic-
testimony/2008-0602-Michalek-corrected-oral.pdf; see also Written Statement of Eric
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Kolchinsky, Managing Director, Moodys Derivatives Group (SPSI Hearing, Apr. 23, 2011)
(Managers of rating groups were expected by their supervisors and ultimately the Board of
Directors . . . to build, or at least maintain, market shares. It was an unspoken understanding that
loss of market share would cause a manager to lose his or her job; [L]owering credit standards
. . . was one easy way for a managing director to regain market share.), available at
http://hsgac.senate.gov/public/index.cfm?FuseAction=Files.View&FileStore_id=bd65f802-961c-
4727-b176-72ece145baef.)
D. Fannie Mae and Freddie Mac Justifiably Relied
on the Misrepresentations and Omissions in the Offering Materials and
Were Damaged by Defendants Fraudulent Conduct
183. Fannie Mae and Freddie Mac are government-sponsored enterprises chartered by
Congress to provide liquidity, stability, and affordability to the U.S. housing and mortgage
markets. In furtherance of this mission, the GSEs purchase mortgages and invest in RMBS.
184. Generally, when purchasing RMBS, the GSEs require compliance with their
investment requirements, as well as various representations and warranties concerning, among
other things, the credit quality of the underlying loans, evaluation of the borrowers ability to
pay, the accuracy of loan data provided, and adherence to applicable local, state, and federal law.
Such representations and warranties were material to the GSEs decisions to purchase RMBS,
including the Certificates.
185. The Fraud Defendants intended for investors, including Fannie Mae and Freddie
Mac, to rely on their representations of material facts about the assets backing the Certificates.
These Defendants regularly provided prospective RMBS investors with information concerning
the volume of their annual securitization business to assure investors that, by virtue of their
expertise in and share of the RMBS market, Fannie Mae and Freddie Mac should rely upon the
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representations and warranties in their Offering Materials. (See, e.g. Prospectus Supplement to
the MSAC 2006-HE8 Securitization, filed November 22, 2006.)
186. The Fraud Defendants knew that Fannie Mae and Freddie Mac had specific
requirements for investing in non-agency mortgage-backed securities and intended for the GSEs
to rely on their fraudulent misstatements as shown by their provision of representations,
warranties and anticipated credit ratings in connection with the Certificates, and their repetition
of false loan statistics in the term sheets, free writing prospectuses, and Prospectus Supplements,
among other materials.
187. In fact, Fannie Mae and Freddie Mac did rely to their detriment on the Fraud
Defendants misrepresentations and material omissions in the Offering Materials.
188. The GSEs reliance was justifiable because the GSEs necessarily were required to
rely upon the Fraud Defendants to provide accurate information regarding the loans. The GSEs
lacked access to the actual loan files and the loan-level data essential to perform statistical tests
with respect to, among other things, owner-occupancy and LTV ratios.
189. The GSEs reliance also was justifiable because industry practice was for an
investor to rely upon the representations and warranties of the sponsors and underwriters
regarding the quality of the mortgage loans and the standards under which they were originated.
Information regarding the originators compliance with underwriting guidelines, owner-
occupancy rates, LTV ratios, and the information provided to credit ratings agencies, was
peculiarly within the knowledge of the Fraud Defendants.
190. The GSEs were induced into buying the Certificates based on the false and
misleading Offering Materials. They would not have purchased the Certificates had they known
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the truth concerning the matters alleged herein. Alternatively, the GSEs suffered damages
because the price they paid for the Certificates was higher than their actual value.
191. From the day the GSEs purchased the Certificates, they suffered injury. As a
result of Defendants misrepresentations, the true value of the Certificates on the date of
purchase was far lower than the price paid for them by the GSEs.
FIRST CAUSE OF ACTION
Violation of Section 11 of the Securities Act of 1933
(Against MS&Co., MSAC, MSC, SASC,
Credit Suisse, RBS and the Individual Defendants)
192. Plaintiff realleges paragraphs 1 through 133 as if fully set forth herein. For
purposes of this cause of action, Plaintiff hereby expressly excludes any allegation that could be
construed as sounding in fraud.
193. This claim is brought by FHFA pursuant to Section 11 of the Securities Act of
1933 and is asserted on behalf of Fannie Mae and Freddie Mac, which purchased the Certificates
issued pursuant to the Registration Statements for the Securitizations listed in paragraph 40.
194. This claim is for strict liability based on the material misstatements and omissions
in the Registration Statements for the 33 Securitizations (as specified in Table 1, supra at
paragraph 41), and is asserted against MS&Co., MSAC, MSC, and SASC, Credit Suisse, RBS
and the Individual Defendants (together, the Section 11 Defendants).
195. MS&Co., Credit Suisse, and/or RBS acted as underwriter in connection with the
sale of the Certificates for each of the 33 Securitizations (as specified in Table 1, supra at
paragraph 41), directly and indirectly participated in distributing the Certificates, and directly
and indirectly participated in drafting and disseminating the Registration Statements. MS&Co.,
Credit Suisse, and/or RBS were underwriters for the Certificates, and are strictly liable for the
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misstatements and omissions in the Registration Statements under Section 11 of the Securities
Act.
196. Depositors MSAC, MSC and SASC filed Shelf Registration Statements (as
specified in Table 2, supra at paragraph 47) pursuant to which the Securitizations were carried
out, and are the issuers of the Certificates issued pursuant to the Registration Statements within
the meaning of Section 2(a)(4) of the Securities Act, 15 U.S.C. 77b(a)(4), and in accordance
with Section 11(a), 15 U.S.C. 77k(a).
197. At the time Depositors MSAC, MSC and SASC filed the relevant Shelf
Registration Statements, the Individual Defendants were officers and/or directors of MSAC,
MSC and SASC (as specified in Table 2, supra at paragraph 47). The Individual Defendants
signed the Shelf Registration Statements, and either signed (or authorized another to sign on their
behalf) the amendments to the Shelf Registration Statements. As such, the Individual
Defendants are strictly liable for the misstatements and omissions in the Shelf Registration
Statements under Section 11 of the Securities Act.
198. At the time that they became effective, each of the Registration Statements, as set
forth above, contained material misstatements of fact and omitted information necessary to make
the facts stated therein not misleading. The facts misstated or omitted were material to a
reasonable investor in the Certificates sold pursuant to the Registration Statements.
199. The untrue statements of material facts and omissions of material fact in the
Registration Statements are principally those set forth herein in Parts (I)(C) and (D) and
Appendix A, and pertain to purported compliance with underwriting guidelines, occupancy
status, loan-to-value ratios and credit ratings.
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200. Fannie Mae and Freddie Mac purchased or otherwise acquired the Certificates
pursuant to the false and misleading Registration Statements and in the primary market. At the
time they purchased the Certificates, Fannie Mae and Freddie Mac were unaware of the false and
misleading statements and omissions alleged herein, and if they had known those facts, they
would not have purchased the Certificates.
201. MS&Co., Credit Suisse, and RBS were obligated to make a reasonable
investigation of the statements contained in the Registration Statements at the time they became
effective to ensure that such statements were true and correct, and that there were no omissions
of material facts required to be stated in order to make the statements contained therein not
misleading. The Individual Defendants owed the same duty with respect to the Shelf
Registration Statements that they signed, which are applicable to all 33 of the Securitizations.
202. MS&Co., Credit Suisse, RBS and the Individual Defendants did not exercise such
due diligence and failed to conduct a reasonable investigation, as alleged in paragraphs 38
through 128. In the exercise of reasonable care, these Defendants should have known of the
false statements and omissions contained in or omitted from the Registration Statements filed in
connection with the Securitizations, as set forth herein. In addition, although the performance of
due diligence is not an affirmative defense available to the Depositors on this strict liability
claim, they nonetheless also failed to take reasonable steps to ensure the accuracy of the
representations made in the Registration Statements.
203. By virtue of the foregoing, Fannie Mae and Freddie Mac sustained substantial
damages, including depreciation in the value of the Certificates, as a result of the misstatements
and omissions in the Registration Statements. Plaintiff is entitled to damages, jointly and
severally, from each of the Section 11 Defendants.
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204. Based on the foregoing, MS&Co., MSAC, MSC SASC, Credit Suisse, RBS, and
the Individual Defendants are jointly and severally liable for their wrongdoing.
SECOND CAUSE OF ACTION
Violation of Section 12(a)(2) of the Securities Act of 1933
(Against Defendants MS&Co., MSAC, MSC SASC, Credit Suisse, and RBS)
205. Plaintiff realleges paragraphs 1 through 133 above as if fully set forth herein. For
purposes of this cause of action, Plaintiff hereby expressly excludes any allegation that could be
construed as sounding in fraud.
206. This claim is brought by Plaintiff pursuant to Section 12(a)(2) of the Securities
Act of 1933 and is asserted on behalf of Fannie Mae and Freddie Mac, which purchased the
Certificates issued pursuant to the Registration Statements in the Securitizations listed in
paragraph 40.
207. MS&Co., Credit Suisse, and RBS are prominently identified as underwriters in
the Prospectuses used to sell the Certificates. MS&Co., Credit Suisse, and RBS offered,
promoted, and/or sold the Certificates publicly, including selling to Fannie Mae and Freddie Mac
their Certificates, as set forth in the Plan of Distribution or Underwriting sections of the
Prospectuses. MS&Co., Credit Suisse, and RBS offered, promoted, and/or sold the Certificates
to Fannie Mae and Freddie Mac as specified in Table 2, supra at paragraph 47.
208. MS&Co., Credit Suisse, and RBS offered, promoted, and/or sold the Certificates
to Fannie Mae and Freddie Mac by means of the Prospectuses that contained untrue statements
of material facts and omitted to state material facts necessary to make the statements, in light of
the circumstances under which they were made, not misleading. MS&Co., Credit Suisse, and
RBS successfully solicited Fannie Mae and Freddie Macs purchases of the Certificates, and
generated millions of dollars in commissions in connection with the sale of the Certificates.
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209. MS&Co., Credit Suisse, and RBS offered the Certificates for sale, sold them, and
distributed them by the use of means or instruments of transportation and communication in
interstate commerce.
210. The Depositors are prominently identified in the Prospectuses for the
Securitizations carried out under the Registration Statements that they filed. These Prospectuses
were the primary documents each used to sell the Certificates for the 30 Securitizations under
those Registration Statements. MSAC, MSC and SASC offered the Certificates publicly and
actively solicited their sale, including to Fannie Mae and Freddie Mac.
211. With respect to the Securitizations for which they filed Registration Statements,
the Depositors offered the Certificates to Fannie Mae and Freddie Mac by means of Prospectuses
that contained untrue statements of material facts and omitted to state material facts necessary to
make the statements, in the light of the circumstances under which they were made, not
misleading. Upon information and belief, the Depositors reviewed and participated in drafting
the Prospectuses.
212. The Depositors offered the Certificates for sale by the use of means or
instruments of transportation and communication in interstate commerce.
213. MS&Co., Credit Suisse, and RBS actively participated in the solicitation of
Fannie Mae and Freddie Macs purchase of the Certificates, and did so in order to benefit
themselves. Such solicitation included assisting in preparing the Registration Statements, filing
the Registration Statements, and/or assisting in marketing and selling the Certificates.
214. Each of the Prospectuses contained material misstatements of fact and omitted
information necessary to make the facts stated therein not misleading. The facts misstated and
omitted were material to a reasonable investor reviewing the Prospectuses.
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215. The untrue statements of material facts and omissions of material fact in the
Registration Statements, which include the Prospectuses, are set forth above in Parts (I)(C) and
(D) and Appendix A and pertain to compliance with underwriting guidelines, occupancy status,
and loan-to-value ratios.
216. MS&Co., Credit Suisse, RBS and the Depositors offered and sold the Certificates
offered pursuant to the Registration Statements directly to Fannie Mae and Freddie Mac,
pursuant to the false and misleading Prospectuses.
217. MS&Co., Credit Suisse, and RBS owed Freddie Mac and Fannie Mae a duty to
make a reasonable and diligent investigation of the statements contained in the Prospectuses, to
ensure that such statements were true, and to ensure that there was no omission of a material fact
required to be stated in order to make the statements contained therein not misleading. MS&Co.,
Credit Suisse, and RBS failed to exercise such reasonable care, and in the exercise of reasonable
care should have known that the Prospectuses contained untrue statements of material facts and
omissions of material facts at the time of the Securitizations as set forth above.
218. Fannie Mae and Freddie Mac did not know of the misstatements and omissions
contained in the Prospectuses at the time they purchased the Certificates. If Fannie Mae and
Freddie Mac had known of those misstatements and omissions, they would not have purchased
the Certificates.
219. Fannie Mae and Freddie Mac acquired the Certificates in the primary market
pursuant to the Prospectuses.
220. Fannie Mae and Freddie Mac sustained substantial damages in connection with
their investments in the Certificates and have the right to rescind and recover the consideration
paid for the Certificates, with interest thereon. Plaintiff hereby seeks rescission and makes any
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necessary tender of its Certificates. In the alternative, Plaintiff seeks damages according to
proof.
THIRD CAUSE OF ACTION
Violation of Section 15 of the Securities Act of 1933
(Against MS, MSMC, SCI, SFM, and the Individual Defendants)
221. Plaintiff realleges paragraphs 1 through 133 above as if fully set forth herein. For
purposes of this cause of action, Plaintiff hereby expressly excludes any allegation that could be
construed as sounding in fraud.
222. This claim is brought under Section 15 of the Securities Act of 1933, 15 U.S.C.
77o (Section 15), against Defendants MS, MSMC, SCI, SFM, and the Individual Defendants
for controlling-person liability with regard to the Section 11 and Section 12(a)(2) causes of
actions set forth above.
223. The Individual Defendants at all relevant times participated in the operation and
management of the Depositors, and conducted and participated, directly and indirectly, in the
conduct of the Depositors business affairs. Specifically: Steven Shapiro was Vice President at
MSAC; Gail P. McDonald was a Director at MSAC; Howard Hubler was a Director at MSAC;
Craig S. Phillips was President and Director at MSAC; Alexander Frank was Treasurer at
MSAC.; David Warren was President and Director at MSC; John E. Westerfield was a Director
at MSC; Steven S. Stern was a Director at MSC; Michael L. Sawyer was President and Director
at SASC; Ernest G. Bretana was Vice President or a Director at SASC; Dean A. Christiansen
was a Director and Board Member at SASC; Orlando Figueroa was a Director at SASC; Robert
B. Eastep was Executive Vice President and CFO at SASC; and Jennifer Sebastian was Vice
President and Treasurer at SASC.
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224. SFM and MSMC (on its own behalf and as the successor in interest to MCI) were
sponsors for the Securitizations carried out pursuant to Registration Statements filed by MSAC,
MSC and SASC (as specified in Table 2, supra at paragraph 47), and culpably participated in
their violations of Sections 11 and 12(a)(2) by initiating these Securitizations, purchasing the
mortgage loans to be securitized, determining the structure of the Securitizations, selecting the
Depositors as special-purpose vehicles, and selecting MS&Co. or the Non-MS Underwriters as
underwriters. As sponsors, SFM and MSMC/MCI knew and intended that the mortgage loans
they purchased would be sold in connection with the securitization process, and that certificates
representing the ownership interests of investors in the mortgages would be issued by the
relevant trusts.
225. SFM and MSMC/MCI sold the mortgage loans to the Depositors (as specified in
Table 1, supra at paragraph 40), and conveyed the mortgage loans to the Depositors pursuant to
an Assignment and Recognition Agreement or a Mortgage Loan Purchase Agreement. SFM and
MSMC/MCI controlled all aspects of the business of the Depositors, who were special-purpose
entities created for the purpose of acting as a pass-through for the issuance of the Certificates.
Upon information and belief, the officers and directors of MSMC and SFM overlapped with the
officers and directors of the Depositors. SFM and MSMC/MCI were able to, and did in fact,
control the contents of the Registration Statements filed by the Depositors, including the
Prospectuses and Prospectus Supplements that contained material misstatements of fact and
omitted facts necessary to make the facts stated therein not misleading.
226. Defendant MS wholly owns MS&Co., MSAC, MSC and MSMC and is the
ultimate parent of SCI, SFM, and SASC. MS, as the sole corporate parent of MS&Co., MSAC,
MSC, and MSMC, had the practical ability, in connection with the Securitizations and the
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issuance and sale of the Certificates, to direct and control the actions of MS&Co., MSAC, MSC,
and MSMC, and in fact exercised such discretion and control over these activities.
227. MS culpably participated in the violations of Section 11 and 12(a)(2) set forth
above. It oversaw the actions of its subsidiaries and allowed them to misrepresent the mortgage
loans characteristics in the Registration Statements and established special-purpose financial
entities such as the Depositors and the issuing trusts to serve as conduits for the mortgage loans.
228. Further, the officers and directors of MS significantly overlapped with the officers
and directors of the Depositors. For example, Defendant Phillips was, at all relevant times, the
Global Head of Securitized Products at MS while also serving as the President and CEO at
MSAC. Similarly, Defendant Warren was, at all relevant times, the Global Head of Structured
Credit Trading at MS while also serving as the President and Director at MSC.
229. MS, MSMC, SCI, and SFM, and the Individual Defendants are controlling
persons within the meaning of Section 15 by virtue of their actual power over, control of,
ownership of, and/or directorship of the Depositors at the time of the wrongs alleged herein and
as set forth herein, including their control over the content of the Registration Statements.
230. Fannie Mae and Freddie Mac purchased the Certificates in the primary market,
which were issued pursuant to the Registration Statements, including the Prospectuses and
Prospectus Supplements, which, at the time they became effective, contained material
misstatements of fact and omitted facts necessary to make the facts stated therein not misleading.
The facts misstated and omitted were material to a reasonable investor reviewing the
Registration Statements.
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231. Fannie Mae and Freddie Mac did not know of the misstatements and omissions in
the Registration Statements; had they known of those misstatements and omissions, they would
not have purchased the Certificates.
232. Fannie Mae and Freddie Mac have sustained damages as a result of the
misstatements and omissions in the Registration Statements, for which they are entitled to
compensation.
233. Plaintiff hereby tenders the Certificates in connection with its request for
rescission.
FOURTH CAUSE OF ACTION
Primary Violations of the Virginia Securities Act
(Against MS&Co., Credit Suisse, RBS, MSAC, MSC, and SASC)
234. Plaintiff re-alleges paragraphs 1 through 133 above as if fully set forth herein.
For purposes of this cause of action, Plaintiff hereby expressly excludes any allegation that could
be construed as sounding in fraud.
235. This claim is brought by Plaintiff pursuant to Section 13.1-522(A)(ii) of the
Virginia Code and is asserted on behalf of Freddie Mac with respect to the Certificates identified
above that were purchased by Freddie Mac and issued pursuant to the Registration Statements.
236. Defendants MSAC, MSC, and SASC made false and materially misleading
statements in the Prospectuses (as supplemented by the Prospectus Supplements, hereinafter
referred to in this Section as Prospectuses) for each Securitization (as specified in Table 2,
supra). Defendants MS&Co., Credit Suisse, and RBS made false and materially misleading
statements in the Prospectuses for the Securitizations effected under the Shelf Registration
Statements.
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237. MS&Co., Credit Suisse, and RBS are prominently identified in the Prospectuses,
the primary documents it used to sell the Certificates. MS&Co., Credit Suisse, and RBS offered
the Certificates publicly, including selling to Freddie Mac the Certificates, as set forth in the
Method of Distribution or equivalent underwriting section of each Prospectus.
238. MS&Co., Credit Suisse, and RBS offered and sold the Certificates to Freddie Mac
by means of the Prospectuses, which contained untrue statements of material facts and omitted to
state material facts necessary to make the statements, in light of the circumstances under which
they were made, not misleading. MS&Co., Credit Suisse, and RBS reviewed and participated in
drafting the Prospectuses.
239. MS&Co., Credit Suisse, and RBS successfully solicited Freddie Macs purchases
of the Certificates. As underwriters, MS&Co., Credit Suisse, and RBS were paid a substantial
commission based on the amount it received from the sale of the Certificates to the public.
240. MS&Co., Credit Suisse, and RBS offered the Certificates for sale, sold them, and
distributed them to Freddie Mac in the State of Virginia.
241. MSAC, MSC, and SASC are prominently identified in the Prospectuses for the
Securitizations carried out under the Registration Statements. These Prospectuses were the
primary documents used to sell Certificates for the Securitizations under the Registration
Statements. MSAC, MSC, and SASC offered the Certificates publicly and actively solicited
their sale, including to Freddie Mac. MSAC, MSC, and SASC were paid a percentage of the
total dollar amount of the offering upon completion of the Securitizations effected pursuant to
the Shelf Registration Statements.
242. With respect to the Securitizations for which it filed the Shelf Registration
Statements, including the related Prospectus Supplements, MSAC, MSC, and SASC offered the
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Certificates to Freddie Mac by means of Prospectuses which contained untrue statements of
material facts and omitted to state material facts necessary to make the statements, in the light of
the circumstances under which they were made, not misleading. MSAC, MSC, and SASC
reviewed and participated in drafting the Prospectuses.
243. Each of MS&Co., Credit Suisse, and RBS, and MSAC, MSC, and SASC, actively
participated in the solicitation of Freddie Macs purchase of the Certificates, and did so in order
to benefit itself. Such solicitation included assisting in preparing the Registration Statements,
filing the Registration Statements, and assisting in marketing the Certificates.
244. Each of the Prospectuses contained material misstatements of fact and omitted
facts necessary to make the facts stated therein not misleading. The facts misstated and omitted
were material to a reasonable investor reviewing the Prospectuses, and specifically to Freddie
Mac.
245. The untrue statements of material facts and omissions of material facts in the
Registration Statements, which include the Prospectuses, are set forth above, and include
compliance with underwriting guidelines, occupancy status, loan-to-value ratios, and accurate
credit ratings.
246. MS&Co., Credit Suisse, and RBS, and MSAC, MSC, and SASC offered and sold
the Certificates directly to Freddie Mac pursuant to the materially false, misleading, and
incomplete Prospectuses.
247. MS&Co., Credit Suisse, and RBS owed to Freddie Mac, as well as to other
investors in these trusts, a duty to make a reasonable and diligent investigation of the statements
contained in the Prospectuses, to ensure that such statements were true, and to ensure that there
was no omission of a material fact required to be stated in order to make the statements
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contained therein not misleading. MSAC, MSC, and SASC owed the same duty with respect to
the Prospectuses for the Securitizations effected under the Shelf Registration Statements.
248. MS&Co., Credit Suisse, RBS, MSAC, MSC, and SASC failed to exercise such
reasonable care. These Defendants in the exercise of reasonable care should have known that the
Prospectuses contained untrue statements of material facts and omissions of material facts at the
time of the Securitizations, as set forth above.
249. In contrast, Freddie Mac did not know, and in the exercise of reasonable diligence
could not have known, of the untruths and omissions contained in the Prospectuses at the time it
purchased the Certificates. If Freddie Mac had known of those untruths and omissions, it would
not have purchased the Certificates.
250. Freddie Mac sustained substantial damages in connection with its investments in
the Certificates and has the right to rescind and recover the consideration paid for the
Certificates, with interest thereon. Plaintiff hereby seeks rescission and makes any necessary
tender of its Certificates. In the alternative, Plaintiff seeks damages according to proof.
FIFTH CAUSE OF ACTION
Controlling Person Liability Under the Virginia Securities Act
(Against MS, MSMC, SCI, SFM, and the Individual Defendants)
251. Plaintiff realleges paragraphs 1 through 133 above as if fully set forth herein. For
purposes of this cause of action, Plaintiff hereby expressly excludes any allegation that could be
construed as sounding in fraud.
252. This claim is brought under Section 13.1-522(C) of the Virginia Code and is
asserted on behalf of Freddie Mac, which purchased the Certificates (identified in Table 10
above) that were issued pursuant to the Registration Statements. This claim is brought against
Defendants MS, MSMC, SCI, SFM, and the Individual Defendants (the Control Persons) for
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controlling-person liability with regard to the claim brought by Plaintiff pursuant to Section 13.1-
522(A)(ii).
253. The Individual Defendants at all relevant times participated in the operation and
management of the Depositors, and conducted and participated, directly and indirectly, in the
conduct of the Depositors business affairs. Specifically: Mr. Shapiro was Vice President at
MSAC; Ms. P. McDonald was a Director at MSAC; Mr. Hubler was a Director at MSAC; Mr.
Phillips was President and Director at MSAC; Mr. Frank was Treasurer at MSAC; Mr. Warren
was President and Director at MSC; Mr. E. Westerfield was a Director at MSC; Mr. Stern was a
Director at MSC.
254. SFM and MSMC (on its own behalf and as the successor in interest to MCI) were
sponsors for the Securitizations carried out pursuant to Registration Statements filed by MSAC,
MSC and SASE (as specified supra), and culpably participated in their violations of Section
13.1-522(A)(ii) by initiating these Securitizations, purchasing the mortgage loans to be
securitized, determining the structure of the Securitizations, selecting the Depositors as special-
purpose vehicles, and selecting MS&Co. or the Non-MS Underwriters as underwriters. As
sponsors, SFM and MSMC/MCI knew and intended that the mortgage loans they purchased
would be sold in connection with the securitization process, and that certificates representing the
ownership interests of investors in the mortgages would be issued by the relevant trusts.
255. SFM and MSMC/MCI sold the mortgage loans to the Depositors (as specified
supra), and conveyed the mortgage loans to the Depositors pursuant to an Assignment and
Recognition Agreement or a Mortgage Loan Purchase Agreement. SFM and MSMC/MCI
controlled all aspects of the business of the Depositors, who were special-purpose entities created
for the purpose of acting as a pass-through for the issuance of the Certificates. Upon information
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and belief, the officers and directors of MSMC and SFM overlapped with the officers and
directors of the Depositors. SFM and MSMC/MCI were able to, and did in fact, control the
contents of the Registration Statements filed by the Depositors, including the Prospectuses and
Prospectus Supplements that contained material misstatements of fact and omitted facts
necessary to make the facts stated therein not misleading.
256. Defendant MS wholly owns MS&Co., MSAC, MSC and MSMC and is the
ultimate parent of SCI, SFM, and SASC. MS, as the sole corporate parent of MS&Co., MSAC,
MSC, and MSMC, had the practical ability, in connection with the Securitizations and the
issuance and sale of the Certificates, to direct and control the actions of MS&Co., MSAC, MSC,
and MSMC, and in fact exercised such discretion and control over these activities.
257. MS culpably participated in the violations of Section 13.1-522(A)(ii) set forth
above. It oversaw the actions of its subsidiaries and allowed them to misrepresent the mortgage
loans characteristics in the Registration Statements and established special-purpose financial
entities such as the Depositors and the issuing trusts to serve as conduits for the mortgage loans.
258. Further, the officers and directors of MS significantly overlapped with the officers
and directors of the Depositors. For example, Defendant Mr. Phillips was, at all relevant times,
the Global Head of Securitized Products at MS while also serving as the President and CEO at
MSAC. Similarly, Defendant Mr. Warren was, at all relevant times, the Global Head of
Structured Credit Trading at MS while also serving as the President and Director at MSC.
259. MS, MSMC, SCI, and SFM, and the Individual Defendants are controlling
persons within the meaning of Section 13.1-522(C) by virtue of their actual power over, control
of, ownership of, and/or directorship of the Depositors at the time of the wrongs alleged herein
and as set forth herein, including their control over the content of the Registration Statements.
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260. Freddie Mac purchased the Certificates, which were issued pursuant to the
Registration Statements, including the Prospectuses and Prospectus Supplements, which
contained material misstatements of fact and omitted facts necessary to make the facts stated
therein not misleading. The facts misstated and omitted were material to a reasonable investor
reviewing the Registration Statements, and specifically to Freddie Mac.
261. Freddie Mac did not know, and in the exercise of reasonable diligence could not
have known, of the misstatements and omissions in the Registration Statements; had Freddie
Mac known of those misstatements and omissions, it would not have purchased the Certificates.
262. Freddie Mac has sustained substantial damages as a result of the misstatements
and omissions in the Registration Statements, for which it is entitled to compensation, and for
which the Control Persons are jointly and severally liable.
SIXTH CAUSE OF ACTION
Primary Violations of the District of Columbia Securities Act
(Against Defendants MS&Co., MSAC, MSC, SASC, Credit Suisse and RBS)
263. Plaintiff realleges paragraphs 1 through 133 above as if fully set forth herein. For
purposes of this cause of action, Plaintiff hereby expressly excludes any allegation that could be
construed as sounding in fraud.
264. This claim is brought by Plaintiff pursuant to Section 31-5606.05(a)(1)(B) of the
District of Columbia Code and is asserted on behalf of Fannie Mae, which purchased the
Certificates issued pursuant to the Registration Statements in the Securitizations listed in
paragraph 40.
265. MS&Co., Credit Suisse, and RBS are prominently identified as underwriters in
the Prospectuses that were used to sell the Certificates. MS&Co., Credit Suisse, and RBS
offered, promoted, and/or sold the Certificates publicly, including selling to Fannie Mae its
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Certificates, as set forth in the Plan of Distribution or Underwriting sections of the
Prospectuses. MS&Co., Credit Suisse, and RBS offered, promoted, and/or sold the Certificates
to Fannie Mae as specified in Tables 10 and 11, supra at paragraph 129.
266. MS&Co., Credit Suisse, and RBS offered, promoted, and/or sold the Certificates
to Fannie Mae by means of the Prospectuses that contained untrue statements of material facts
and omitted to state material facts necessary to make the statements, in light of the circumstances
under which they were made, not misleading. MS&Co., Credit Suisse, and RBS successfully
solicited Fannie Maes purchases of the Certificates, and generated millions of dollars in
commissions in connection with the sale of the Certificates.
267. MS&Co., Credit Suisse, and RBS offered the Certificates for sale, sold them, and
distributed them to Fannie Mae in the District of Columbia.
268. The Depositors are prominently identified in the Prospectuses for the
Securitizations carried out under the Registration Statements that they filed. These Prospectuses
were the primary documents each used to sell the Certificates for the 30 Securitizations under
those Registration Statements. MSAC, MSC and SASC offered the Certificates publicly and
actively solicited their sale, including to Fannie Mae. MSAC, MSC and SASC were paid a
percentage of the total dollar amount of the offering upon completion of the Securitizations
effected pursuant to the Registration Statements that they filed.
269. With respect to the Securitizations for which they filed Registration Statements,
the Depositors offered the Certificates to Fannie Mae by means of Prospectuses that contained
untrue statements of material facts and omitted to state material facts necessary to make the
statements, in the light of the circumstances under which they were made, not misleading. Upon
information and belief, the Depositors reviewed and participated in drafting the Prospectuses.
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270. MS&Co., Credit Suisse, and RBS actively participated in the solicitation of
Fannie Maes purchase of the Certificates, and did so in order to benefit themselves. Such
solicitation included assisting in preparing the Registration Statements, filing the Registration
Statements, and/or assisting in marketing and selling the Certificates.
271. Each of the Prospectuses contained material misstatements of fact and omitted
facts necessary to make the facts stated therein not misleading. The facts misstated and omitted
were material to a reasonable investor reviewing the Prospectuses.
272. The untrue statements of material facts and omissions of material facts in the
Registration Statements, which include the Prospectuses, are set forth above in Parts (I)(C) and
(D) and Appendix A and pertain to compliance with underwriting guidelines, occupancy status,
loan-to-value ratios, and accurate credit ratings.
273. MS&Co., Credit Suisse, RBS and the Depositors offered and sold the Certificates
offered pursuant to the Registration Statements directly to Fannie Mae, pursuant to the false and
misleading Prospectuses.
274. MS&Co., Credit Suisse, and RBS owed Fannie Mae a duty to make a reasonable
and diligent investigation of the statements contained in the Prospectuses, to ensure that such
statements were true, and to ensure that there was no omission of a material fact required to be
stated in order to make the statements contained therein not misleading. MS&Co., Credit Suisse,
and RBS failed to exercise such reasonable care, and in the exercise of reasonable care should
have known that the Prospectuses contained untrue statements of material facts and omissions of
material facts at the time of the Securitizations as set forth above.
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275. Fannie Mae did not know of the misstatements and omissions contained in the
Prospectuses at the time they purchased the Certificates. If Fannie Mae had known of those
misstatements and omissions, they would not have purchased the Certificates.
276. Fannie Mae sustained substantial damages in connection with their investments in
the Certificates and have the right to rescind and recover the consideration paid for the
Certificates, with interest thereon. Plaintiff hereby seeks rescission and makes any necessary
tender of its Certificates. In the alternative, Plaintiff seeks damages according to proof.
SEVENTH CAUSE OF ACTION
Controlling Person Liability Under the District of Columbia Securities Act
(Against MS, MSMC, SCI, SFM, and the Individual Defendants)
277. Plaintiff realleges paragraphs 1 through 133 above as if fully set forth herein. For
purposes of this cause of action, Plaintiff hereby expressly excludes any allegation that could be
construed as sounding in fraud.
278. This claim is brought under Section 31-5606.05(c) of the District of Columbia
Code against Defendants MS, MSMC, SCI, SFM, and the Individual Defendants for controlling-
person liability with regard to the Section 31-5606.05(a)(1)(B) causes of action set forth above.
279. The Individual Defendants at all relevant times participated in the operation and
management of the Depositors, and conducted and participated, directly and indirectly, in the
conduct of the Depositors business affairs. Specifically: Steven Shapiro was Vice President at
MSAC; Gail P. McDonald was a Director at MSAC; Howard Hubler was a Director at MSAC;
Craig S. Phillips was President and Director at MSAC; Alexander Frank was Treasurer at
MSAC.; David Warren was President and Director at MSC; John E. Westerfield was a Director
at MSC; Steven S. Stern was a Director at MSC; Michael L. Sawyer was President and Director
at SASC; Ernest G. Bretana was Vice President or a Director at SASC; Dean A. Christiansen
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was a Director and Board Member at SASC; Orlando Figueroa was a Director at SASC; Robert
B. Eastep was Executive Vice President and CFO at SASC; and Jennifer Sebastian was Vice
President and Treasurer at SASC.
280. SFM and MSMC (on its own behalf and as the successor in interest to MCI) were
sponsors for the Securitizations carried out pursuant to Registration Statements filed by MSAC,
MSC and SASE (as specified in Table 2, supra at paragraph 47), and culpably participated in
their violations of Section 31-5606.05(a)(1)(B) by initiating these Securitizations, purchasing the
mortgage loans to be securitized, determining the structure of the Securitizations, selecting the
Depositors as special purpose vehicles, and selecting MS&Co. or the Non-MS Underwriters as
underwriters. As sponsors, SFM and MSMC (on its own behalf and as successor-in-interest to
MCI) knew and intended that the mortgage loans they purchased would be sold in connection
with the securitization process, and that certificates representing the ownership interests of
investors in the mortgages would be issued by the relevant trusts.
281. SFM and MSMC (on its own behalf and as successor-in-interest to MCI) sold the
mortgage loans to the Depositors (as specified in Table 1, supra at paragraph 41), and conveyed
the mortgage loans to the Depositors pursuant to an Assignment and Recognition Agreement or a
Mortgage Loan Purchase Agreement. SFM and MSMC (on its own behalf and as successor-in-
interest to MCI) controlled all aspects of the business of the Depositors, who were special
purpose entities created for the purpose of acting as a pass-through for the issuance of the
Certificates. Upon information and belief, the officers and directors of MSMC and SFM
overlapped with the officers and directors of the Depositors. SFM and MSMC (on its own
behalf and as successor-in-interest to MCI) were able to, and did in fact, control the contents of
the Registration Statements filed by the Depositors, including the Prospectuses and Prospectus
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Supplements that contained material misstatements of fact and omitted facts necessary to make
the facts stated therein not misleading.
282. Defendant MS wholly owns MS&Co., MSAC, MSC and MSMC and is the
ultimate parent of SCI, SFM, and SASC. As the sole corporate parent of MS&Co., MSAC,
MSC, and MSMC, MS had the practical ability to direct and control the actions of MS&Co.,
MSAC, MSC, and MSMC in issuing and selling the Certificates, and in fact, exercised such
discretion and control over the activities of MS&Co., MSMC, MSAC, and MSC.
283. MS culpably participated in the violations of Section 31-5606.05(a)(1)(B) set
forth above. It oversaw the actions of its subsidiaries and allowed them to misrepresent the
mortgage loans characteristics in the Registration Statements and established special-purpose
financial entities such as the Depositors and the issuing trusts to serve as conduits for the
mortgage loans.
284. Further, the officers and directors of MS significantly overlapped with the officers
and directors of the Depositors. For example, Defendant Phillips was, at all relevant times, the
Global Head of Securitized Products at MS while also serving as the President and CEO at
MSAC. Similarly, Defendant Warren was, at all relevant times, the Global Head of Structured
Credit Trading at MS while also serving as the President and Director at MSC.
285. MS, MSMC, SCI, and SFM, and the Individual Defendants are controlling
persons within the meaning of Section 31-5606.05(c) of the District of Columbia Code by virtue
of their actual power over, control of, ownership of, and/or directorship of the Depositors at the
time of the wrongs alleged herein and as set forth herein, including their control over the content
of the Registration Statements.
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286. Fannie Mae purchased the Certificates in the primary market, which were issued
pursuant to the Registration Statements, including the Prospectuses and Prospectus Supplements,
which, at the time they became effective, contained material misstatements of fact and omitted
facts necessary to make the facts stated therein not misleading. The facts misstated and omitted
were material to a reasonable investor reviewing the Registration Statements.
287. Fannie Mae did not know of the misstatements and omissions in the Registration
Statements; had they known of those misstatements and omissions, they would not have
purchased the Certificates.
288. Fannie Mae has sustained damages as a result of the misstatements and omissions
in the Registration Statements, for which they are entitled to compensation.
289. Plaintiff hereby tenders the Certificates in connection with its request for
rescission.
EIGHTH CAUSE OF ACTION
(Common Law Fraud Against MS&Co,
MSAC, MSC, MSMC, SASC, SFM, Credit Suisse, and RBS)
290. Plaintiff realleges paragraphs 1 through 191 as if fully set forth herein.
291. The material representations set forth in Parts (I)(C) and (D) and in Appendix A
were fraudulent, and the Fraud Defendants representations falsely and misleadingly
misrepresented and omitted material statements of fact. The representations at issue are
identified in Parts (I)(C) and (D) above and further identified in Appendix A.
292. The Fraud Defendants knew their representations and omissions were false and/or
misleading at the time they were made, or made such representations and omissions recklessly
without knowledge of their truth or falsity.
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293. Each of the Fraud Defendants made the misleading statements with the intent and
for the purpose of inducing Fannie Mae or Freddie Mac to purchase the Certificates.
294. Fannie Mae and Freddie Mac justifiably relied on the Fraud Defendants false
representations and misleading omissions.
295. But for the Fraud Defendants fraudulent misrepresentations and omissions
regarding the Fraud Defendants underwriting practice and quality of the loans making up the
securitizations, Fannie Mae and Freddie Mac would not have purchased the Certificates.
296. As a result of the foregoing, Fannie Mae and Freddie Mac have suffered damages
in an amount to be proven at trial. Plaintiff hereby demands rescission and makes any necessary
tender of the Certificates.
297. Because the Fraud Defendants defrauded Fannie Mae and Freddie Mac willfully
and wantonly, and because, by their acts, the Fraud Defendants knowingly affected the general
public, including but not limited to all persons with interest in the Certificates, Plaintiff is
entitled to recover punitive damages.
NINTH CAUSE OF ACTION
(Aiding and Abetting Against MSMC, SFM, MSAC, MSC, and SASC)
298. Plaintiff realleges paragraphs 1 through 191 as if fully set forth herein.
299. This is a claim for aiding and abetting fraud, in the alternative, should it be found
that the Underwriting Defendants alone are liable for fraud. This claim is brought against
MSMC, SFM, MSAC, MSC, and SASC arising from the intentional and substantial assistance
each rendered to MS&Co., Credit Suisse, and RBS (the Selling Underwriters) to advance the
fraud on Fannie Mae and Freddie Mac.
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300. Through overlapping personnel, strategies, and intertwined business operations,
and the fluid transfer of information among the Defendants, each of MSMC, SFM, MSAC,
MSC, and SASC knew of the Selling Underwriters fraudulent scheme to offload the credit risks
of non-agency loans to investors, including Fannie Mae and Freddie Mac. Each of these
Defendants acted in concert to defraud Fannie Mae and Freddie Mac.
301. MSMC, SFM, MSAC, MSC, and SASC through their employees and
representatives, substantially assisted in, among other things: (a) the extension of warehouse
loans to originators; (b) acquiring the underlying mortgage loans from the originators; (c)
packaging up those loans into pools which were deposited into the Trust; (d) waiving into the
collateral pools of the Trusts loans previously rejected by Clayton or otherwise non-compliant
loans, despite the lack of compensating factors; (e) creating and structuring the Trusts whose
Certificates would be sold to investors including Fannie Mae and Freddie Mac and (f) preparing
the Registration Statements which would be used to market the Certificates.
302. The Selling Underwriters would not have been able to implement their fraud
against Fannie Mae and Freddie Mac without such substantial assistance.
303. Through overlapping personnel, strategies, and intertwined business operations,
and the fluid transfer of information among the Defendants, each of the Morgan Stanley
Defendants knew of the fraud perpetrated on Fannie Mae and Freddie Mac.
304. Defendants could not have perpetrated their fraud without the substantial
assistance of each other defendant, and they all provided financial, strategic, and marketing
assistance for their scheme. Defendants are highly intertwined and interdependent businesses
and each benefitted from the success of the scheme. Through the fraudulent sale of the
Certificates to the GSEs, the Selling Underwriters were able to materially improve their financial
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condition by reducing their exposure to declining subprime-related assets and garnering millions
of dollars in fees from the structuring and sale of the Certificates.
305. As a direct, proximate, and foreseeable result of the conduct of MSMC, SFM,
MSAC, MSC, and SASC Fannie Mae and Freddie Mac have suffered and will continue to suffer
damages in an amount to be proven at trial. Plaintiff hereby demands rescission and makes any
necessary tender of the Certificates.
306. Because the Fraud Defendants defrauded Fannie Mae and Freddie Mac willfully
and wantonly, and because, by their acts, the Fraud Defendants knowingly affected the general
public, including but not limited to all persons with interest in the Certificates, Plaintiff is
entitled to recover punitive damages.
TENTH CAUSE OF ACTION
(Negligent Misrepresentation Against the Selling Underwriters, MSAC, MSC, and SASC)
307. Plaintiff realleges paragraphs 1 through 191 as if fully set forth herein.
308. Between September 12, 2005 and September 28, 2007, the Selling Underwriters
and MSAC, MSC, and SASC (the Depositor Defendants) sold the Certificates to the GSEs as
described above. Because the Depositor Defendants owned and then conveyed the underlying
mortgage loans to the issuing trusts, the Depositor Defendants had unique, exclusive, and special
knowledge about the mortgage loans in the Securitizations through their possession of the loan
files and other documentation.
309. Likewise, as underwriters of the Securitizations, the Selling Underwriters had the
access to and ability to review loan file information and were obligated to perform adequate due
diligence to ensure the accuracy of the Offering Materials. Accordingly, the Selling
Underwriters had unique, exclusive, and special knowledge about the underlying mortgage loans
in the Securitizations.
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310. The Selling Underwriters and the Depositor Defendants also had unique,
exclusive, and special knowledge of the work of third-party due diligence providers, such as
Clayton, who identified significant failures of originators to adhere to the underwriting standards
represented in the Registration Statements. The GSEs lacked access to borrower loan files prior
to the closing of the Securitizations and their purchase of the Certificates. Accordingly, when
determining whether to purchase the Certificates, the GSEs could not evaluate the underwriting
quality or the servicing practices of the mortgage loans in the Securitizations on a loan-by-loan
basis. The GSEs reasonably relied on the knowledge and representations of the Selling
Underwriters and Depositor Defendants regarding the underlying mortgage loans.
311. The Selling Underwriters and Depositor Defendants were aware that the GSEs
reasonably relied on these Defendants for complete, accurate, and timely information. The
standards under which the underlying mortgage loans were actually originated were known to
these Defendants and were not known, and could not be determined, by the GSEs prior to the
closing of the Securitizations. The GSEs therefore reasonably relied upon these Defendants
misrepresentations and omissions in the Offering Materials.
312. The Selling Underwriters and Depositor Defendants breached their duty of
disclosure by making false or misleading statements of material facts to the GSEs when they
knew or should have known of the falsity of their statements. The misrepresentations are set
forth in Parts (I)(C) and (D) above and Appendix A.
313. In addition, having false or misleading representations about the underlying
collateral in the Securitizations and the facts bearing on the riskiness of the Certificates, the
Selling Underwriters and Depositor Defendants had a duty to correct the misimpressions left by
their statements, including with respect to any half truths. The Selling Underwriters and
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Depositor Defendants failed to correct in a timely manner any of their misstatements or half
truths.
314. The GSEs reasonably relied on the information provided by the Selling
Underwriters and Depositor Defendants, and as a result, the GSEs suffered damages in an
amount to be determined at trial.
PRAYER FOR RELIEF
WHEREFORE, Plaintiff prays for relief as follows:
An award in favor of Plaintiff against all Defendants, jointly and severally, for::
a. Rescission and recovery of the consideration paid for the Certificates, with
interest thereon (in connection with this request for rescission, the Certificates are hereby
tendered to the Defendants);
b. Each GSEs monetary losses, included any diminution in value of the Certificates,
as well as lost principal and lost interest payments thereon;
c. Punitive damages;
d. Attorneys fees and costs;
e. Prejudgment interest at the maximum legal rate; and
f. Such other and further relief as the Court may deem just and proper.
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DATED: New York, New York
September 2, 2011
KASOWITZ, BENSON, TORRES
& FRIEDMAN LLP
By: __/s/ Marc E. Kasowitz______________________
Marc E. Kasowitz (mkasowitz@kasowitz.com)
Hector Torres (htorres@kasowitz.com)
Michael S. Shuster (mshuster@kasowitz.com)
Christopher P. Johnson (cjohnson@kasowitz.com)
Michael Hanin (mhanin@kasowitz.com)
Kanchana Wangkeo Leung (kleung@kasowitz.com)
1633 Broadway
New York, New York 10019
(212) 506-1700
Attorneys for the Plaintiff
Federal Housing Finance Agency